Commission staff working document accompanying document to the Communication from the Commission to the Council and the European Parliament - The long-term Sustainability of public finances in the EU {COM(2006) 574 final}
Date: 2006-10-12
Institutions: European Commission
Subjects: EU Member State, gross domestic product, impact study, national budget, pension scheme, population ageing, public debt, public finance













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52006SC1247

Commission staff working document accompanying document to the Communication from the Commission to the Council and the European Parliament - The long-term Sustainability of public finances in the EU {COM(2006) 574 final}  /* SEC/2006/1247 */  









[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |
Brussels, 12.10.2006
SEC(2006) 1247
COMMISSION STAFF WORKING DOCUMENT
Accompanying document to the COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT The long-term sustainability of public finances in the EU
{COM(2006) 574 final}
EUROPEAN
COMMISSION
DIRECTORATE-GENERAL FOR
Economic and Financial affairs
The long-term sustainability of PUBLIC FINANCES IN the EUropean union
(The complete and definitiveversion will be published asEuropean Economy n° 4/2006)

 European Economy
The Long-term Sustainability of Public Finance in the European Union
A report by the Commission services
SEC(2006) xxx
http://ec.europa.eu/economy_finance/publications_en.htm
Acknowledgements
This report was prepared in the Directorate-General of Economic and Financial Affairs under the direction of Klaus Regling, Director-General, and Servaas Deroose, Director for the Economy of the Euro Area and the Union.
The main contributors were Elena Flores, Antoine Deruennes, Per Eckefeldt, and Marko Mršnik.
Specific contributions were provided by Declan Costello, Giuseppe Carone, Declan Costello, Nuria Diez Guardia, Gilles Mourre, Joao Nogueira Martins, Bartosz Przywara and Aino Salomäki.
The country sections in Chapter VI benefited from comments from desk officers in the Directorate for the Economies of the Member States under the responsibility of Director Marco Buti.
Elena Flores coordinated and supervised the production of the report. Fabrizio Melcarne was responsible for statistical and editorial work.
Comments and suggestions by colleagues in the Directorate-General for Economic and Financial Affairs as well as by other services of the Commission are gratefully acknowledged.
Secretarial support was provided by Maria Davi-Pilato and Dominique Prins.
Comments on the report would be gratefully received and should be sent to:
Directorate-General for Economic and Financial Affairs
Macroeconomy of the euro area and the EU
Public Finances in the euro area and the EU
European Commission
B-1049 Brussels
or by e-mail to Elena.Flores@ec.europa.eu


 Abbreviations and symbols used
Member States
BE Belgium
CZ Czech Republic
DK Denmark
DE Germany
EE Estonia
EL Greece
ES Spain
FR France
IE Ireland
IT Italy
CY Cyprus
LV Latvia
LT Lithuania
LU Luxembourg
HU Hungary
MT Malta
NL The Netherlands
AT Austria
PL Poland
PT Portugal
SI Slovenia
SK Slovak Republic
FI Finland
SE Sweden
UK United Kingdom
EUR-12 European Union Member States having adopted the single currency (BE, DE, EL, ES, FR, IE, IT, LU, NL, AU, PT, FI), i.e. countries participating in the economic and monetary union without a derogation
EU-25 European Union, 25 Member States
EU-15 European Union, 15 Member States before 1. May 2004 (EUR-12 plus DK, SE and UK)
EU-10 European Union, 10 Member States that joined the EU on 1. May 2004 (CZ, EE, CY, LV, LH, HU, MT, PL, SI, SK)
Other
AR Ageing Report
CAB Cyclically-Adjusted Balance
CBO Congress Budget Office
DR Debt Requirement in 2050
EDP Excessive Deficit Procedure
EMU Economic and Monetary Union
EPC Economic Policy Committee
ERM II European Exchange Rate Mechanism, replacing the original ERM in 1999
ESA95 European System of National Accounts 1995
GDP Gross Domestic Product
IBP Initial Budgetary Position
IMF International Monetary Fund
LTC Long-Term Change in the budgetary position
MTO Medium-Term Objective
NAIRU Non-Accelerating Inflation Rate of Unemployment
PAYG Pay-As-You-Go
PEP Pre-accession Economic Programmes
RPB Required Primary Balance
SCP Stability and Convergence Programmes
SFA Stock Flow Adjustment
SGP Stability and Growth Pact
SNA United Nations System of National Accounts
VAT Value-Added Tax


 Table of contents
Chapter I: Long-term sustainability of public finances 15
1. Sustainability of public finances in view of ageing populations 17
1.1. Concept of sustainability of public finances 17
1.2. The sustainability indicators 18
1.3. Deriving the sustainability indicators 18
2. Projecting budgetary developments 19
2.1. Projections of government age-related expenditure 19
2.2. Projecting budgetary balances over a long period 20
3. Interpreting the sustainability indicators 22
3.1. Information on the size of adjustment and the cost of delay 22
3.2. Measure of implicit liabilities 22
3.3. The indicators have no normative content 22
3.4. The indicators do not assess intergenerational equity 23
3.5. The indicators are not sufficient to give a full overview of possible sustainability risks 24
Chapter II: Results of the sustainability analysis 28
1. Overall results of the sustainability indicators and debt projections 29
1.1. The quantitative indicators 29
1.2. Government debt projections 33
2. Comparison with the results of the public finance sustainability analysis in the 2005/06 assessment round of Stability and Convergence programmes 34
3. Comparison of long-term pension projections 37
Chapter III: Sensitivity analysis 41
1. The budgetary impact of modifying underlying assumptions 43
2. Sensitivity tests on the underlying demographic and macro-economic assumptions 43
2.1. Life expectancy 43
2.2. Higher labour productivity growth 44
2.3. Higher employment and higher employment of older workers 45
2.4. Higher interest rate 45
3. Alternative scenarios for health-care and long-term care 47
3.1. Health-care 47
3.2. Long-term care 48
4. Illustrating the sustainability impact of attaining the medium-term objective 49
4.1. The quantitative indicators 49
4.2. Government debt projections 53
5. Conclusions 54
Chapter IV: Qualitative factors 55
1. Government debt and the long-term sustainability of public finances 57
Recent dynamics government debt in the EU Member States 57
2. Pension expenditure projections and risks to public finances 61
2.1. Decrease in the relative level of pensions and risks to public finances 62
Main risks for public finances 62
Assessing risks 63
2.2. The current level of public and private pension expenditure and the current distribution of pensions 64
2.3. Future coverage of private occupational and voluntary pensions 66
2.4. Effective age of retirement 67
2.5. Conclusions 68
3. Revenue projections 70
3.1. Current approach in the EU surveillance framework and alternative approaches by Member States 70
3.2. Treatment of additional revenue projections in the sustainability assessment 72
3.3. Changes in property income over time 73
Property income and proposed way forward 73
Projecting property income 74
3.4. Conclusions 75
4. Stock flow adjustment 78
5. Tax burden 81
6. Contingent liabilities 83
Chapter V: Overall assessment of the risks to the sustainability of public finances 85
1. Reaching an overall assessment of the risks to the long-term sustainability of public finances 87
2. Main sustainability challenges that Member States are facing 90
Chapter VI: Country analysis 93
Belgium 96
The Czech Republic 99
Denmark 102
Germany 105
Estonia 108
Greece 111
Spain 114
France 118
Ireland 121
Italy 124
Cyprus 127
Latvia 130
Lithuania 132
Luxembourg 135
Hungary 138
Malta 141
The Netherlands 144
Austria 147
Poland 150
Portugal 153
Slovenia 156
Slovakia 158
Finland 161
Sweden 164
The United Kingdom 167
Chapter VII: Resources 171
1. References 172
2. Glossary 176
ANNEX I: Deriving the sustainability indicators 180
ANNEX II: Sensitivity tests 188
ANNEX III: Council opinions on the 2005/06 Stability and Convergence Programmes 191
List of tables
Table I.1. Summarizing the indicators 19
Table I.2. Adjustment to the primary balance and the debt concept and sources 21
Table I.3. Projected changes in age-related public expenditure between 2004 and 2030/50 (% of GDP) 27
Table II.1. Results of the sustainability gap calculations in the baseline scenario (% GDP) 30
Table II.2. Government balances (% of GDP) 32
Table II.3. Required primary balance (% of GDP) 33
Table II.4. Projected debt developments in the EU Member States (% of GDP) 33
Table II.5: Change in the age-related budgetary items (between last year of the programme and 2050) 35
Table II.6. Estimated and actual government balances in 2005 36
Table II.7 Evolution of pension expenditure compared: EPC and SCP projections (as change in % of GDP between 2005-2005) 38
Table II.8 Main factors with an impact on the pension projection results over time 39
Table III.1. Impact on the sustainability indicator of changes in demographic and macroeconomic assumptions (deviation from S2 in % points of GDP) 44
Table III.2. Impact on the sustainability indicator of alternative health-care assumptions (deviation from S2 in % points of GDP) 46
Table III.3. Change in the age-related budgetary items up to 2050 (% of GDP) 47
Table III.4. Impact on the sustainability indicator of alternative long-term care assumptions (deviation from S2 in % points of GDP) 48
Table III.5. Government balances in 2005 and the MTOs compared (% of GDP) 51
Table III.6. Results of the sustainability gap calculations in the MTO scenario (% of GDP) 52
Table III.7. Debt developments in the Member States assuming that the MTOs are reached in 2010 (% of GDP) 54
Table IV.1. Gross government debt 2000-2007 (% of GDP) 58
Table IV.2. Change in the benefit ratio over time 61
Table IV.3. Coverage of current pension expenditure for the 12 Member States 64
Table IV.4. Level of assets in occupational/individual pension schemes and coverage 66
Table IV.5. Age at retirement of new flows of retirees and average exit age from the labour market 67
Table IV.6. Employment rates in the EU in 2003 and in the projections 68
Table IV.7: Projections of property income 75
Table IV.8. Property income in EU (% of GDP) 76
Table IV.9. Decomposition of D4 for some countries 77
Table IV.10. Total taxes in the EU Member States (% of GDP) 82
Table V.1. Main factors considered in reaching an overall assessment of public finance sustainability risks 90
List of graphs
Graph I.1. Sustainability gap and required primary balance 23
Graph I.2 Age pyramids for EU25 population in 2004 and 2050 25
Graph I.3 Baseline labour force projection (change in % of people aged 15-64 between 2003 and 2050) 26
Graph I.4 Projected (annual average) potential growth rates in the EU15 and EU10 and their determinants 26
Graph II.1. Decomposition of the S2 indicator 31
Graph II.2. Debt developments in the EU and the euro area 2005-2050 34
Graph II.3: S2 indicator in the baseline scenario compared with the results of the 2005/06 SCPs assessment round and main source of differences 36
Graph III.1. The cost of delay (in % of GDP) 50
Graph III.2. Debt developments in the EU and the euro area 53
Graph IV.1. Composition of the change in debt levels, 2000-2005 59
Graph IV.2. Impact on public finances of maturing private pension schemes 71
Graph IV.3. Stock-flow adjustment in the EU MS, average 2002-2005 (% of GDP) 79
Graph V.1. Overall risk classification and the sustainability gap (S2 in the baseline scenario) 89
List of boxes
Box I.1 Demographic and economic projections in the Ageing Report 25
Box III.1. The 'cost of delay' indicator 50
Box IV.1. Relative level of pensions, replacement rates and the benefit ratio 62
Box IV.2. Impact of indexation rule after retirement 65
Chapter I
Long-term sustainability of public finances
Summary
Population ageing in the European Union will have a significant impact on economic growth and lead to significant pressures to increase public spending. In order to gauge the scale of this challenge, the assessment of long-term sustainability of public finances is part of the regular EU budgetary surveillance, based on the long-term age-related government expenditure projections and on the budgetary strategies presented in the Stability and Convergence Programmes. In this context, consistency between short to medium-term budgetary targets and long-term sustainability is at the core of the analysis.
The issue of long-term sustainability is a multi-faceted one. It involves avoiding imposing an excessive burden on future generations and ensuring the country's capacity to appropriately adjust budgetary policy in the medium and long run. For this purpose, the results of the common long-term age-related expenditure projections under current policies, provided in spring 2006 by the EPC/Commission and the current budgetary position are the key inputs to the analysis of the sustainability of public finances.
The new projections provide a comparable, transparent and robust basis for assessing the budgetary implications of demographic change and the sustainability of public finances across Member States. Based on the projected expenditure trends, deficit and debt levels are projected over the long-term. Debt sustainability is derived from the intertemporal budget constraint. It imposes that current total liabilities of the government, i.e. the current public debt and the discounted value of future expenditure including the budgetary impact of ageing populations, should be covered by the discounted value of future government revenue. If current policies ensure that the intertemporal budget constraint is respected, current policies are sustainable.
The assessment of long-term sustainability of public finances goes beyond answering the question whether current policies are sustainable or not. An estimation of the size of the budgetary imbalances is also needed to understand the challenge that policy-makers face. This is provided by sustainability gap indicators that measure the size of a required permanent budgetary adjustment (e.g. a constant reduction of non age-related public expenditure as a share of GDP or a constant increase in public revenue as a share of GDP) that enables to meet one of the following conditions: i) reaching a target of 60% of GDP for the Maastricht debt in 2050 (the S1 indicator), ii) fulfilling the inter-temporal budget constraint over an infinite horizon (the S2 indicator).
The sustainability indicators provide a firm basis to identify the size and the main source of risks to public finance sustainability in the EU Member States. They provide information on and a measure of the size of the required adjustment and of the cost that would result from a delay in addressing the long-term sustainability. In addition, they provide a measure of implicit liabilities – government commitments - related to ageing populations. The indicators have however neither normative content nor do they assess intergenerational equity. To reach an overall assessment of the sustainability of public finances, other factors are taken into account, which allow a better qualification of the assessment with regard to where the main risks are likely to stem from.
.
Sustainability of public finances in view of ageing populations
In the coming decades, Europe's population will undergo dramatic demographic changes due to low fertility rates, continuous increases in life expectancy and the retirement of the baby-boom generation. Ageing populations will pose major economic, budgetary and social challenges. It is expected to have a significant impact on growth and lead to significant pressures to increase public spending.[1] This will make it difficult for Member States to maintain sound and sustainable public finances in the long-term. This is of particular importance in Economic and Monetary Union, as high deficits and rising debt in some countries leading to unsustainable public finances might have an adverse impact on macro-economic conditions for other EMU countries. Therefore, ensuring fiscal sustainability requires time-consistent policies, which involves addressing budgetary imbalances before the budgetary impact of ageing sets in.
Concept of sustainability of public finances
The issue of debt or fiscal sustainability is a multi-faceted issue and there is no agreed definition on what a sustainable debt position is. Blanchard et al (1990) consider that " it is essentially about whether, based on the policy currently on the books, a government is headed towards excessive debt accumulation ".
The time horizon, over which one analyses debt sustainability, depends on its purpose. In some cases, it might be relatively short and the purpose is to evaluate short- to medium-term dynamics of debt (e.g. in the Commission's assessments of the updates of the stability and convergence programmes for the purpose of the budgetary surveillance) or to analyse the dynamics of debt servicing, including in many cases external debt service (e.g. IMF assessment of default risks). [2] In the short to medium-term context, the assessment of the sustainability is conditional upon factors, such as the structure of debt according to maturity, currency of denomination and average terms of new commitments. If the sustainability of external debt is considered, additional factors such as exchange rate dynamics, exports and imports of goods and services in foreign currency and net foreign direct investment are taken into account. Such type of sustainability analysis is mostly used for emerging markets or low-income countries. [3]
In the case of the assessment of the long-term sustainability of public finances, the time horizon needs to be considerably longer to assess the budgetary impact of government commitments, notably regarding pensions. Against such a significant budgetary challenge posed by ageing populations, the latter has been the preoccupation of the EU in recent years and is the prime focus of this report.
Many EU Member States conduct long-term projections and analyse long-term budgetary trends, in particular in view of assessing the budgetary impact of the projected demographic changes. Moreover, other international organizations like the IMF assess long term sustainability (mainly for industrialised countries).[4]
For the purposes of assessing sustainability of public finances over the long-term in view of the budgetary challenge posed by ageing populations, debt sustainability may be defined in two alternative ways:
-  A first definition of sustainability is derived from the government's intertemporal budget constraint . It imposes that current total liabilities of the government, i.e. the current public debt and the discounted value of all future expenditure, should be covered by the discounted value of all future government revenue over an infinite horizon. In other words, the government must run sufficiently large primary surpluses in the future to cover the increasing cost of ageing and to pay off interest on outstanding debt. If current policies ensure that the government's intertemporal budget constraint is fulfilled, current policies are financially sustainable. However, since the government's intertemporal budget constraint is defined over an infinite horizon, it does not specify when the adjustment of revenues or expenditures, if any, has to be made: the required adjustment may be made today or at any point in the future. Furthermore, this condition does not imply that debt should reach a specific level (whether it is zero or not).[5]
-  The abovementioned condition over an infinite horizon can be approximated by looking over a finite period and to assess if current policies ensure a specific debt target to be reached at a given date. While this finite condition does not ensure the sustainability of public finances after the target year, it gives a clearer policy objective than the intertemporal budget constraint. Given that there are as many possible conditions as there are debt concepts, debt targets and target years, the EU adopted an approach of this second definition, which draws on the compliance with the EMU debt requirement in 2050. [6]
The sustainability indicators
The assessment of long-term sustainability of public finances goes beyond answering the question whether current policies are sustainable or not. An estimation of the size of the budgetary imbalances is also needed. This is provided by sustainability gap indicators that measure the size of a permanent budgetary adjustment (e.g. a constant reduction of non age-related public expenditure as a share of GDP or a constant increase in public revenue as a share of GDP) that enables to meet one of the following conditions:
-  reaching a target of 60% of GDP for the Maastricht debt in 2050 (the S1 indicator );
-  fulfilling the inter-temporal budget constraint over an infinite horizon (the S2 indicator ).
It should be clear that translating the two sustainability conditions into a permanent adjustment of public expenditure or public revenue has no normative content in the sense that it would favour one policy option over another. It mainly aims at giving a measure of the sustainability risk that is intuitive and "easily" understandable. Alternative presentations of these conditions are also possible. They can be translated into a required primary balance over the medium term, i.e. expressed as a target rather than as a deviation from this target. They can also be translated into a 'stock' measure, often called implicit liabilities or implicit debt, instead of a 'flow' measure as given by the sustainability indicators. The two latter measures should therefore be considered as alternative presentations of the sustainability indicators rather than as new or different indicators (see section 3.2 below for a more detailed presentation).
Deriving the sustainability indicators
The two sustainability indicators translate current and future budgetary imbalances into synthetic measures that can be simply expressed as a sum of three different components:
-  the first component relates to the relative position of the current primary balance compared to the primary balance that stabilises the level of debt as a share of GDP over the long-term, further recalled as the debt-stabilizing primary balance . If the initial primary balance is not large enough, the government debt will be on an explosive path even before considering the impact of ageing.[7]
-  the second component is specific to the S1 indicator and relates to the initial level of debt. If a country has an initial level of debt larger than 60% of GDP, reaching the debt-stabilizing primary balance will not be sufficient to ensure that the debt reference value is achieved in 2050 and an additional adjustment is therefore necessary.
-  the third component relates to the increase in age-related expenditure in the future due to ageing populations. Fulfilling the first two conditions will not be enough to avoid excessive debt accumulation if expenditure are expected to increase (or equivalently if the primary balance is expected to deteriorate) as a share of GDP in the future. An additional adjustment is therefore necessary to cover the increase in expenditure up to 2050 (in the case of S1) or over an infinite horizon (in the case of S2).
This decomposition of the indicators (see Table I.1) gives additional insight to understand the numerical results of the indicators. It also enables to determine for each country whether the risks to the sustainability of public finances stem from the initial budgetary position and/or a large increase in age-related expenditure over the long-term.
Table I.1. Summarizing the indicators
Impact of |
Initial budgetary position | Debt requirement in 2050 | Long-term changes in the primary balance |
Source: Commission services (See table A.1.1. in Annex 1 for a mathematical derivation).
A high positive contribution of the current budgetary position (1st column) signals that the current level of the primary balance, if maintained, will lead to an explosive debt without considering the effect of ageing. A high positive contribution of the long-term changes in the primary balance (last column) signals that the impact of ageing on public expenditure is expected to be large. In this context, a low sustainability gap may cover quite different situations. In some cases, it stems from a debt-stabilizing budget balance and a small ageing impact on public finances. In other cases, it stems from a very strong budgetary position today with large primary surpluses that enable to compensate a significant projected rise in age-related expenditure.
Projecting budgetary developments
Projections of government age-related expenditure
Budgetary projections over the long-term are based on a set of assumptions which can potentially have a very large impact on the results. In a multilateral context, having a common setting for the projections for the purposes of analysing and assessing the long-term sustainability of public finances is therefore essential to ensure comparability of results and equal treatment. This was the main motivation behind the 2006 common budgetary projections exercise, carried out by European Commission together with national authorities working through the Economic Policy Committee. [8]
In a repeat of an exercise carried out in 2001, the long-term projections on how ageing will affect the labour market, economic growth and age-related public expenditure items have been published. [9] The projections were made on the basis of “no policy change”, only reflecting currently enacted legislation, although account is taken of provisions in enacted legislation that enter into force over time. Equally, they reflect the current behaviour of economic agents, without assuming any future changes in behaviour. Projections for public spending on pensions were made using the models of the Member States' authorities. Projections for health care, long-term care, education and unemployment transfers were made using common models developed by the European Commission. The ECOFIN Council of February 2006 agreed that the projections provided a comparable and comprehensive picture of the economic and budgetary impact of ageing populations and they would provide the basis for assessing the sustainability of public finances at EU level.
The projections used in the baseline scenario for analysing public finance sustainability include the following five age-related expenditure items:
-  Gross public pension expenditure . This consists of pensions for old-age, early retirement, disability, survivors (widows and orphans) and for other specific purposes which should be considered as equivalents or substitutes for these types of pensions, including pensions for reduced capacity to work or for labour market reasons. Pension expenditures are in nearly all countries the most important age-related government expenditure item, both in terms of size at present and in the future and in terms of differences across the EU Member States. The substantial increase in the old-age dependency ratio over the coming decades in the EU leads to increasing pension expenditure in almost all EU countries. However, there is a large diversity with regard to the size of the increase, reflecting mainly differences in the pension arrangements that prevail in the different Member States. Such diversity gives rise to different degrees of risk in terms of public finance sustainability.
-  Health-care expenditure . Several scenarios for future trends with regard to expenditure on health-care are available in the Ageing Report. For the purposes of analysing and assessing public finance sustainability, a 'reference' scenario from the Ageing Report is used. This scenario takes account of the combined effects of ageing, the health care status of elderly citizens and the income elasticity of demand for health care goods and services. It is notably assumed that the health status of the populations will improve by half as much as in the constant health scenario.[10]
-  Long-term care expenditure . Several scenarios for future trends with regard to expenditure on long-term care are available in the Ageing Report. As it is the case for health-care, a 'reference' scenario from the Ageing Report has been used. This scenario assumes that age-specific disability rates decline at half the pace of age-specific mortality rates. In particular, it is assumed that age-specific disability rates decrease by half of the decrease in the age-specific mortality rates. In this scenario about half of the projected gains in life expectancy up to 2050 would be spent in good health and free of disability. Long-term care projections show quite different patterns across countries mainly due to large differences in initial coverage. Finally, the Ageing Report did not include projections for long-term care for Greece, France, Portugal, Cyprus, Estonia, and Hungary. Since the completion of the Ageing Report, Estonia, France, Hungary and Portugal have provided the required data so that the Commission could run the projections for these countries. However, for Greece and Cyprus, the lack of long-term care projections implies that the total increase in age-related expenditures, and therefore the risks to the long-term sustainability of public finances will be underestimated.
-  Education expenditure and unemployment benefits . This consists of direct education expenditure and transfers to households and institutions; and, expenditure on unemployment benefits that follow from the assumptions made on the working-age population, labour market participation and unemployment rates, respectively. The projections show that the relief on public finances due to a lower unemployment rate and a lower relative share of young people can only marginally compensate for the increase of expenditure on pensions, health-care and long-term care.
These long-term common projections estimate the budgetary impact of ageing based on commonly agreed underlying assumptions and under policies currently in place in the EU Member States. They do not assess the efficiency of such policies nor their desirability compared to alternative policies. Indeed, they do not assume changes in policies that could result in an improvement in the health status of the population or higher educational attainment levels. Implementing such policies could contribute to higher labour force participation and higher labour productivity and thus in higher economic activity.[11] Moreover, such policy changes could result in lower public spending over the long-term and thus contribute to the sustainability of public finances. The budgetary impact of alternative assumptions e.g. with respect to the health status of the population is discussed in Chapter III. Moreover, additional sensitivity tests are produced to analyse the impact of various changes in the key assumptions. The demographic and economic projections underlying the government expenditure projections are summarised in Box I.1.
Projecting budgetary balances over a long period
The long-term budgetary projections from the Ageing Report are the main input to project future budgetary developments. To extrapolate debt developments and to calculate the sustainability indicators, one also needs projections and/or assumptions for other public expenditure and revenue items over a long period of time under current policies (see Table I.2):[12]
-  interest expenditure are derived according to the evolution of debt and the projected real interest rate which is set at 3% for all countries over the entire period; [13]
-  Table I.2. Adjustment to the primary balance and the debt concept and sources
Primary balance | Debt level |
Initial government items | Primary balance i.e. government balance excluding interest expenditure | Maastricht gross debt |
Corrections | Cyclical adjustment | European Commission Spring 2006 economic forecast) | - |
One-off or temporary measures | European Commission Spring 2006 economic forecast | - |
Liquid financial assets in public pension funds | 2005/06 updates of the Stability and Convergence programme |
Switch to private pension fund (if the Eurostat decision is not already implemented) | Eurostat (Euro-indicators news release 48/2006 24 April 2006)* | Eurostat (Euro-indicators news release 48/2006 24 April 2006) |
"Adjusted" government items | Structural primary balance | Adjusted gross debt |
Note:* Interest expenditure are estimated with the level of additional debt and the implicit level of the interest rate in 2005.
Source: Commission services.
-  other primary expenditure , as well as total revenue , is assumed to be constant as a share of GDP and equal to the last known year.[14] Temporary factors (business cycle and one-off measures) on the general government balance are however netted out so that such effects are not extended over the long-term. [15]
Two additional corrections have been implemented:
-  first , a number of Member States have switched a part of their social security pension schemes into defined-contribution funded schemes. According to the decision of Eurostat (2 March 2004) those schemes should be recorded in the private sector in the national accounts..[16] This implies that pension outlays from those schemes are not included in the long-term projections for public pensions. Symmetrically, the corresponding revenues and the assets in those funds deductible from the Maastricht debt should not be considered as part of the general government.[17] Given that countries are required to implement the Eurostat decision by March 2007, adjusting the budget balance figure is necessary for countries that currently publish general government figures including those funds (DK, HU, PL, SK, SE);
-  second , the debt concept used by the Commission, the Maastricht gross debt, is only one of the several different definitions of public debt that can be envisaged. The gross debt concept is defined in the Protocol on excessive deficit procedure annexed to the Maastricht Treaty.[18] The concept has the advantage of being measurable with a high degree of certainty and being comparable across countries in the EU. The choice of focussing on gross debt is therefore logical. However, governments may hold assets which contribute positively to the sustainability of public finances. Since reducing debt or accumulating assets in public pension funds has a similar effect on fiscal sustainability, with the latter strategy however not reflected in the gross debt measure, the net position of liquid consolidated pension fund assets is taken into account in the analysis of public finances sustainability.[19]
Finally, given that the common projections are conducted for the period up to 2050, the total primary balance of the government is assumed to remain constant as a share of GDP after 2050 in order to calculate the intertemporal constraint over an infinite horizon (S2 indicator).
Interpreting the sustainability indicators
Information on the size of adjustment and the cost of delay
First, the sustainability indicators are used to assess if current policies in a country are sustainable or not. A positive value suggests that current policies are not sustainable while a negative value indicates that current policies are sustainable. Projecting long-term budgetary trends requires several assumptions which may not materialise and are therefore subject to uncertainty. As the sensitivity analysis carried out in Chapter III reveals, sustainability indicators are indeed sensitive to a number of assumptions. It may therefore be difficult to assess exactly whether current policies are sustainable or not - particularly for countries for which indicators are close to zero.
Second, the sustainability indicators also give the indication of the magnitude of the budgetary challenge caused by ageing populations: this is particularly important in the budgetary surveillance framework, since fiscal situations are very different across the EU and since countries have reformed pension systems to various degrees. It is also possible to calculate the budgetary cost of a delay in budgetary consolidation: the additional explanatory value of the sustainability indicators is that it estimates the cost of a delay calculated as the increase in those indicators that would follow a postponing of the budgetary adjustment by, e.g. five years.
Measure of implicit liabilities
Sustainability indicators also provide an estimate of implicit liabilities. Implicit liabilities are liabilities that may not be backed by law or contractual obligations but are simply grounded in strong expectations by the public. There are several different concepts for implicit liabilities.[20]
An important aspect is the coverage which can be limited to the pension rights that current workers have accrued so far in the system (sometimes referred to as 'accrued pension debt'). Alternatively, it can be extended to also include future pension rights as well as the continuation of current policies with regard to other public expenditure. Assessing sustainability of current policies needs to measure implicit liabilities on the assumption that the current rules will apply also in the future for current and future generations.
Furthermore, the notion of implicit liabilities could be gross or net of future revenues. A forward-looking concept of implicit liabilities to be meaningful needs to consider not only the future implicit commitments of governments but also their entitlement to receive revenues, i.e. net implicit liabilities.
Against this background, the analysis of public finance sustainability made by the Commission and the Council in the context of budgetary surveillance considers a relatively broad definition of net implicit liabilities that incorporates the projected impact of ageing populations over the long-term. In particular, it includes the projected change in the age-related expenditure items covered by the common projections exercise.
As shown in section I.2 above, the S2 sustainability indicator provides an estimate of the gap between current policies and sustainable policies, which expresses the current level of debt plus the net present value of all future primary deficits as a flow measure i.e. as a perpetual annuity, constant as a share of GDP. It is also possible to express this gap in present value terms, i.e. as a stock measure. The current level of debt (explicit debt) less the net present value of the sustainability gap (net implicit debt) is therefore a measure of the current net implicit debt of the general government (the statistical annex, section 4 provides a formal description). In practice, 'stock' measures (net implicit liabilities) are more volatile than 'flow' measures (sustainability gap indicators), especially with relation to the assumed discount rate. It is arguably also more intuitive to understand the policy implications of a constant budgetary adjustment rather than an additional stock of debt. Measuring long-term public finance imbalances as 'flow' indicators (i.e. sustainability gaps) is therefore preferred to equivalent 'stock' measures (i.e. implicit net debt).
The indicators have no normative content
Sustainability gap indicators are sometimes called tax gap indicators, which refers to one possible interpretation of the indicators i.e. the permanent increase in the tax ratio that would ensure sustainability. This expression can however be misleading since there are different ways to ensure long-term sustainability and a uniform increase in tax over time is only one of them.
Graph I.1. Sustainability gap and required primary balance
[pic] Note: The graph is an illustration the evolution for the primary balance in the "baseline" scenario. The sustainability gap is assumed to be 1.5% of GDP. If the country was to reach a sustainable position only through medium-term budgetary consolidation, reaching the RPB over the medium-term would be sufficient.
Source: Commission services .
Namely, governments typically choose a combination of consolidating the budgetary position over the medium-term (either through expenditure reduction and/or tax hikes) and implementing structural reforms aiming at curbing long-term public expenditure (through lower nominal spending or higher GDP growth). Sustainability indicators should therefore be understood as measures of imbalances and not as a policy invitation to increase taxes in the medium term or to undertake any other specific policy measure.
Instead of presenting public finances imbalances as a gap towards a sustainable situation, it is also possible to present the resulting target in terms of a primary balance that would result from a consolidation in the medium term that ensures sustainability (the required primary balance ). It is also a more stable indicator than the sustainability gap.[21]
The primary balance will evolve in the future in line with the impact of ageing on expenditure (see Graph I.1), but the RPB indicates a sufficient starting position that, if reached, ensures sustainability of public finances under a no policy change assumptions. The required primary balance is not a fixed target over time, not even if structural reforms are implemented.
The RPB can be used to compare the actual or planned budgetary strategy with the structural primary balance required for fulfilling the inter-temporal budget constraint. In practice, in the EU sustainability analysis framework, the required primary balance ( RPB ) is calculated as the projected average structural primary balance over the first five years after the programme period plus the S2 indicator and in this report it is calculated over the period 2011-2015.
The indicators do not assess intergenerational equity
Intergenerational fairness is also one of the motivations to address long-term sustainability issues in order to avoid leaving "unpaid bills" to future generations. However, to assess this one needs information on distribution of social benefits, public spending and taxes to different age cohorts in the past and in the future.[22] While partly implicit in the calculations of the indicators, this cannot be done through this aggregate approach used in this report.
The indicators are not sufficient to give a full overview of possible sustainability risks
The sustainability indicators are synthetic tools but they do not necessarily encompass all factors that are relevant for the sustainability analysis.
They are based on demographic, economic and budgetary projections that are surrounded by uncertainties and as such may under- or overestimate risks.
They can only assess the factors taken into account in the framework (mainly ageing and current budgetary imbalances) and therefore do not address other issues that may be relevant for debt dynamics (contingent liabilities, competing budgetary pressures from non age-related expenditure, etc). They do not assess the feasibility of possible government actions. For example, indicators are independent of the current level of taxation, which if already high, may prove difficult to be raised further.
The intertemporal budget constraint does not impose any level of debt. Moreover, an adverse macroeconomic shock or other budgetary developments may lead to an explosive debt already in the short run. These factors point to a careful interpretation of the indicators and need for integrating such considerations in the formulation of an overall assessment (see Chapter IV).
Box I.1 Demographic and economic projections in the Ageing Report
European populations will be much older by 2050 Population ageing in Europe is occurring due to the interaction of four different demographic developments, each with its own cause, and each having different economic policy repercussions. The magnitude, timing and relative importance of these four demographic trends differs considerably across EU countries (for details, see Chapter 2.1 in the Ageing Report (2006)).[23] First, in all EU countries, fertility rates are below the natural replacement rate needed to stabilise the size and age structure of the population. For the EU25, fertility rates in baseline scenario are projected to rise from 1.5 in 2004 to 1.6 by 2030 and to stay constant around that level until 2050. Second, the recent decline in fertility rates followed the post-war baby-boom, and their impending entry into retirement will lead to a transitory (albeit lasting several decades) increase in the old-age dependency ratio which will act as a downward drag on per capita GDP growth and place upward pressure on public spending. Third, having increased by 8 years since 1960, life expectancy at birth is projected to rise by a further 6.3 years for males and by 5.1 years for females by 2050, with most gains resulting from lower mortality rates at older ages. Fourth, annual net migration inflows are projected to fall from an estimated 1.3 million people in 2004 to some 800,000 people by 2015 (0.2% of the population). These net inflows cumulate to close to 40 million people between 2004 and 2050, but they are insufficient to stabilise the age structure of the population. The population in the EU25 will be slightly smaller, but much older, in 2050 (see Graph I.2). Between 2004 and 2050, the number of young persons in the EU25 (aged 0-14) is projected to drop by 19%. From an economic perspective, the key change concerns the working-age population (15-64), which will fall by 48 million, or 16%. In contrast, the elderly population aged 65+ will rise sharply, by 58 million (or 77%) and the fastest growing segment of the population will be the very old (80+) and rise by almost 32 million, or 174%. The old-age dependency ratio (the number of people aged 65 years and above, relative to those between 15 and 64) is projected to double to 51% by 2050 which means the EU will move from having four to only two persons of working-age for every elderly citizen aged 65 or above. Graph I.2 Age pyramids for EU25 population in 2004 and 2050 2004 2050 [pic][pic] Source: EPC and European Commission (2006). Main repercussions for Europe's labour markets and potential growth The overall employment rate of the EU25 is projected to rise from 63% in 2004 to 67% by 2010 and to 70% by 2020. This improved performance mainly results from higher female employment rates, which are projected to rise from just over 55% in 2004 to almost 65% by 2025. The increase is explained by the gradual replacement of older women by younger women who have higher educational attainment and a stronger attachment to the labour market. In addition, the employment rate of older workers (age 55 to 64) is projected to massively increase from 40% in 2004 to 59% in 2025. This reflects the large increases of 5p.p. observed since 2000 (a remarkable reversal of the decades long trends towards earlier retirement during a period slow economic growth) as well as the estimated positive effects of recent pension reforms. Rising employment rates, however, can only provide a temporarily cushion, and eventually the weight of demographic change prevails (see Graph I.3). Three distinct time periods can be observed. Between 2004 and 2011, the size of the EU25 working age population and overall employment levels will continue to rise, and thus can be considered as a "window of opportunity" when conditions will be relatively favourable to undertake structural reforms. Between 2012 and 2017, rising employment rates will offset the projected decline in the size of the working-age population brought about by the baby-boom generation entering retirement. After 2018, the trend towards higher female employment rates will have come to an end and in the absence of further pension reform, the employment rate of older workers is projected to reach a steady state. Having increased by some 20 million between 2004 and 2017, employment during this last period is projected to contract by almost 30 million, giving a reduction of 9 million over the entire 2004-50 time horizon. For the EU25, the annual average potential GDP growth rate is projected to decline from 2.4% in the period 2004 to 2010 to only 1.2% between 2031 and 2050. For the EU10, the fall is much steep, in part due to their less favourable demographic prospects. The sources of growth will alter dramatically. Employment will make a positive contribution to growth in both the EU15 and the EU10 up to 2010, but becomes neutral in the period 2011-2030 and turn significantly negative thereafter. Over time, productivity will become the dominant source of growth, see Graph I.4. Graph I.3 Baseline labour force projection (change in % of people aged 15-64 between 2003 and 2050) [pic] Source: EPC and European Commission (2006). Graph I.4 Projected (annual average) potential growth rates in the EU15 and EU10 and their determinants [pic] [pic] Source: EPC and European Commission (2006). The overall impact of ageing population on public spending Overall, ageing populations is projected to lead to increases in public spending in most Member States by 2050 on the basis of current policies, although there is a wide degree of diversity across countries (see Table I.3). For the EU15 and the Euro area as a whole, public spending is projected to increase by about 4 percentage points between 2004 and 2050. For the EU10, the increase in the overall age-related spending is projected to rise by only about 1.5 percentage points. This apparently low budgetary impact of ageing is mainly due to the sharp projected drop in public pension spending in Poland, which (in common with several other EU10 countries) is partly the result of the switch from a public pension scheme into a private funded scheme. Excluding Poland, age-related spending in the other EU10 countries would increase by more than 5 percentage points of GDP. Most of the projected increase in public spending will be on pensions, health care and long-term care. Potential offsetting savings in terms of public spending on education and unemployment benefits are likely to be limited. |
Table I.3. Projected changes in age-related public expenditure between 2004 and 2030/50 (% of GDP)
[pic]
Total expenditure for pensions does not include Greece. For long-term care, there are no projections available for Greece and Cyprus. Since the release of the Ageing report, FR, PT, EE and HU have provided the data required to conduct the projections for long-term care for these countries. Table I.3 include these projections. The projection results for public spending on long-term care for Germany does not reflect current legislation where benefit levels are fixed. A scenario which comes closer to the current setting of legislation projects that public spending would remain constant as a share of GDP over the projection period.
Note: these figures refer to the baseline projections for social security spending on pensions, education and unemployment transfers. For health care and long-term care, the projections refer to “AWG reference scenarios”
Source: EPC and European Commission (2006).
Chapter II
Results of the sustainability analysis
Summary
The analysis in this chapter reveals that in the absence of reform measures and budgetary consolidation, a considerable sustainability gap of about 3½% of GDP, i.e. the gap between the structural budgetary position in 2005 and a sustainable position, emerges in both the EU and the euro area. Unless measures are taken to fill this gap, the government debt/GDP ratio is projected to remain above 60% over the coming decades for the EU as a whole and towards 2020, it is projected to start rising considerably, reaching almost 200% of GDP in 2050. On the basis of current policies, 11 countries will have a debt/GDP ratio above the 60% of GDP reference value by 2030 and by 2050; another 7 countries will have been added to the list of 'high-debt' countries, implying that debt to GDP ratio will be above 60% in more than two thirds of the Member States.
There is a large variety in terms of the size of the sustainability gap across the EU Member States. This implies that based on the current budgetary position and with no changes in policies, an adjustment is necessary so as to render the public finances sustainable over the long-term for most Member States. In about half of the Member States, a considerable adjustment, of more than 2% of GDP, is required.
The sustainability indicators are decomposed into the impact of: (i) the initial budgetary position which illustrates whether the public finances are sustainable, considering only the current budgetary position, i.e. the current structural primary balance and the current level of government debt; and (ii) the long-term budgetary impact of ageing which reflects the impact of the projected change in age-related government expenditure on public finances.
The initial budgetary position (IBP) illustrates that the public finances are on an unsustainable path even before considering the long-term budgetary impact of ageing populations in about half of the Member States. This implies that for these Member States strengthening of the fiscal position is a matter of urgency, particularly for those which have a high debt/GDP ratio (Italy and Greece). The long-term budgetary impact of ageing (LTC) is most significant in more than a third of Member States, with an increase of close to 5% of GDP or more. These countries have so far made only limited progress in reforming their pension systems or are experiencing maturing pension systems.
The quantitative results in this report are to a large degree similar to those in the 2005/06 assessment round of SCPs although differences emerge due to the use of national projections in the previous exercise as well as due to the 2005 fiscal outturns which were in several cases better than estimated in the 2005/06 stability and convergence programmes, owing in most cases to better-than-expected tax receipts.
Overall results of the sustainability indicators and debt projections
The quantitative indicators
Table II.1 presents the results of the quantitative indicators, which have been calculated on the basis of the structural budgetary position in 2005 and the projected change in age-related expenditure in the period to 2050 according to the methodology described in Chapter I (henceforth referred to as the baseline scenario). A decomposition of the indicators is made in order to determine whether the risks to public finance sustainability can be attributed to the current budgetary position and/or to the long-term budgetary impact of ageing. In particular, this decomposition distinguishes between the impact on the sustainability indicators (S1 and S2) from:
(i) the initial budgetary position – i.e. the gap between the structural primary balance in 2005 and the long-term debt-stabilizing primary balance;[24] and,
(ii) the long-term change in the budgetary position – i.e. the impact of the rise in age-related expenditure on the indicators.[25]
The analysis reveals that there is a large variety in terms of the size of the sustainability gaps as well as of the relative importance of the initial budgetary position (IBP) and the pure impact of ageing (LTC) (see Table II.1 and Graph II.1). Overall, a majority of Member States have sustainability gaps; 16 Member States according to the S1 indicator, and 20 Member States according to the more stringent S2 indicator. This implies that based on the current budgetary position and with no changes in policies, an adjustment is necessary so as to render the public financed sustainable over the long-term for most Member States.
In about half of the Member States, a considerable adjustment, of more than 2% of GDP, is required (see Graph II.1). In the EU as a whole and in the euro-area, the sustainability gap is about 2¼ % of GDP according to the S1 indicator and about 3½ % of GDP according to the S2 indicator. In both cases, the long-term budgetary impact of ageing is the main factor behind the sustainability gaps. The EU aggregates however mask considerable variety between the Member States.
The long-term budgetary impact of ageing
The indicator reflects the large differences of the budgetary impact of ageing on public finances and notably the large differences between countries with regard to the change in pension expenditure to 2050 – ranging from a reduction in Estonia, Malta and Poland to an increase of more than 10% of GDP in Cyprus. It reflects the diversity in public pensions arrangements, their degree of maturity and the effects of pension reforms enacted so far. Differences in other age-related expenditure items projections are smaller; the difference between the projected highest and lowest increase is respectively 1.7% and 1.9% of GDP for expenditure on long-term care and education; around 1% of GDP for health-care expenditure and 0.5% of GDP for unemployment benefits. The projected increase in health-care and long-term care is, aside from the projected demographic change, notably affected by current spending as a share of GDP, i.e. the current public provision of health-care and long-term care.
The decomposition of the sustainability gap indicators provides information on the pure budgetary impact of ageing, the long-term change in the budgetary position (LTC) . The size of the contribution of the LTC for the S2 indicator is in general higher than for the S1 indicator, as the latter only takes into account budgetary developments up to 2050 (see Annex I for more details). However, the ranking of the countries according to the S2 indicator corresponds relatively well with that of the S1 indicator across countries (see Table II.1). In the following paragraphs the results from the S2 indicator are referred to:[26]
-  The long-term budgetary impact of ageing (LTC) is very significant in Luxemburg, Cyprus, Slovenia, Portugal, Ireland, Spain, Belgium, Hungary and the Czech Republic, with an increase of close to 5% of GDP or more. These countries have so far made only limited progress in reforming their pension systems or are experiencing maturing pension systems. In some countries (e.g. Hungary and Slovenia), pension reforms were introduced in the late 1990s which curtailed pension spending; however, recent policies have gone in the opposite direction, resulting in part in a back-tracking of the previous reform.
Table II.1. Results of the sustainability gap calculations in the baseline scenario (% GDP)
Change in age-related expenditure |
S1 | S2 |
2001-2005 | Difference between | 2005 | 2005 |
average | 2005 and 2001 | outturn | outturn |
BE | 0.2 | 0.5 | 0.6 | 0.1 |
CZ | -4.3 | 3.1 | -2.5 | -1.4 |
DK | 2.9 | 3.8 | 5.4 | 5.2 |
DE | -3.4 | 0.3 | -3.0 | -3.1 |
EE | 1.5 | 0.9 | 1.5 | 1.5 |
EL | -5.9 | 0.1 | -5.3 | -5.3 |
ES | -0.2 | 2.8 | 1.3 | 1.3 |
FR | -3.3 | 0.1 | -2.5 | -3.1 |
IE | 0.0 | 2.2 | 1.5 | 1.9 |
IT | -3.5 | 0.7 | -3.4 | -3.9 |
CY | -4.0 | 1.2 | -2.1 | -2.9 |
LV | -1.2 | 1.8 | -0.2 | -0.1 |
LT | -1.4 | 0.2 | -1.2 | -1.1 |
LU | 1.2 | -6.5 | -1.3 | -1.3 |
HU | -5.6 | -2.4 | -5.8 | -6.3 |
MT | -6.1 | 5.0 | -2.4 | -3.1 |
NL | -1.0 | 2.3 | 1.0 | 1.0 |
AT | -0.7 | -0.8 | -1.0 | -1.0 |
PL | -3.3 | 0.7 | -2.6 | -2.6 |
PT | -3.9 | 0.3 | -5.1 | -5.2 |
SI | -2.5 | 3.2 | -1.4 | -1.5 |
SK | -4.3 | 3.8 | -2.4 | -1.6 |
FI | 3.6 | -1.6 | 3.2 | 3.2 |
SE | 1.6 | 0.7 | 3.0 | 2.6 |
UK | -2.3 | -3.7 | -3.3 | -3.3 |
Source: Commission services.
As shown in Chapter I, a change in the initial structural primary balance results in, ceteris paribus , a corresponding change in a sustainability indicator. In practical terms, an improvement in the structural primary balance of e.g. 1% of GDP reduces, ceteris paribus , the initial budgetary position and the sustainability gap by 1% of GDP.
The current budgetary position in 2005 can be compared to the recent past. Table II.2 provides the cyclically-adjusted balances for 2005, on average over the period 2001-2005, and the change in the cyclically adjusted balance between 2001 and 2005.[29] This table also provides the structural balance in 2005, i.e. the cyclically-adjusted balance net of one-offs and temporary measures.
It reveals that the cyclically-adjusted balances (CABs) were better in 2005 than on average over the period 2001-2005 in 18 countries (1% point of GDP or more in 11 of those) while for 6 countries the 2005 CAB was weaker than the average over 2001-2005.
Overall, for the EU25, the cyclically-adjusted budgetary position in 2005 was ½% of GDP higher than the average over the period 2001-2005.[30]
As noted above, one way to cope with the budgetary implications of ageing is to achieve and maintain sound public finances. This can be illustrated by the required primary balance (RPB), which is derived from the S2 sustainability indicator. The RPB indicates the structural primary budgetary position over the medium-term that is consistent with sustainable public finances. The RPB as well as the structural primary balances are shown in Table II.3.
In this table two sets of structural primary balances are given for countries which have not yet implemented the Eurostat decision regarding the classification of funded defined contribution pension schemes but which are required to do so from March 2007 (DK, HU, PL, SK, SE). The figure in parenthesis includes the revenue reducing impact of the implementation of this reclassification. Given that the required primary balance is calculated excluding funded defined contribution pension schemes on the expenditure side, the required primary balance should be compared to the current structural primary balance excluding the revenue from those pension schemes.
Table II.3. Required primary balance (% of GDP)
Structural | Required | Increase in |
primary | primary | age-related |
balance | balance | expenditure |
2005 | Average | between 2010 |
2011-2015* | and 2050 |
BE | 4.5 | 6.2 | 6.6 |
CZ | -0.2 | 5.4 | 7.7 |
DK | 7.1 (6.2) | 3.5 | 4.5 |
DE | -0.3 | 4.4 | 4.0 |
EE | 1.7 | -1.0 | -1.8 |
EL | -0.3 | 2.8 | 1.4 |
ES | 3.1 | 6.4 | 8.9 |
FR | -0.5 | 3.4 | 3.2 |
IE | 3.1 | 5.5 | 7.8 |
IT | 0.6 | 3.8 | 2.3 |
CY | 0.5 | 9.0 | 11.7 |
LV | 0.5 | 1.7 | 1.6 |
LT | -0.3 | 1.9 | 2.1 |
LU | -1.2 | 7.7 | 8.4 |
HU | -2.5 (-3.6) | 6.2 | 7.1 |
MT | 0.9 | 0.2 | -0.6 |
NL | 3.6 | 4.4 | 5.2 |
AT | 1.7 | 2.2 | 1.1 |
PL | -0.2 (-1.7) | -0.4 | -3.2 |
PT | -2.5 | 7.6 | 9.7 |
SI | 0.2 | 7.3 | 9.9 |
SK | 0.2 (-0.4) | 2.9 | 3.7 |
FI | 4.7 | 3.4 | 5.0 |
SE | 4.2 (3.2) | 2.2 | 2.4 |
UK | -1.1 | 3.8 | 4.2 |
Note: the required primary balance is given as an average over the period 2011-2015. In the assessment of the stability and convergence programmes, the required primary balance was calculated as an average of the required primary balance over the next five years after the programme period, which ends in 2008, 2009 and 2010 depending on the country. A common period of 2011-2015 for all countries ensures relatively comparable results with the last and future rounds of assessment of stability and convergence programmes.
Source: Commission services.
The required primary balance is the primary balance that is sufficient to pay interest on outstanding debt and to cover the increase in age-related expenditure: it therefore mainly depends on the projected increase in age-related expenditure and, to a lesser degree, on the current level of the debt. There is a large dispersion with regard to the required primary balance among Member States, ranging from almost 10% of GDP to below zero, which mainly reflects the large dispersion of the projected changes in age-related expenditure (see last column of Table II.3). Reaching and sustaining very high structural primary balances implies running considerable government surpluses, which might prove difficult in view of competing budgetary pressures.
Government debt projections
Another way to look at the prospects for long-term public finance sustainability is to project the debt/GDP ratio over the long-term using the same assumptions as for the calculations of S1 and S2. The debt/GDP ratio is projected to remain above 60% of GDP over the coming decades for the EU as a whole and towards 2020, it is projected to start rising considerably, revealing that the public finances are on an unsustainable path (see Graph II.2). The projected deterioration of the public debt situation is more pronounced in the euro area than in the entire EU due to a higher initial level of debt.
The debt/GDP ratio is currently above the Treaty reference value of 60% of GDP in nine countries (BE, DE, EL, FR, IT, CY, MT, AT and PT), which makes debt reduction a matter of urgency in these cases (see Table II.4). For countries with a very high government debt level, i.e. above 100% of GDP such as Greece and Italy, public finance consolidation is therefore of utmost importance. The issue of the importance of the current level of debt in the context of the sustainability of public finances is discussed further in Chapter IV.1 of this report.
Table II.4. Projected debt developments in the EU Member States (% of GDP)
Gross debt |
2005 | 2010 | 2030 | 2050 |
BE | 93.3 | 72 | 31 | 83 |
CZ | 30.5 | 28 | 49 | 207 |
DK | 35.8 | 6 | -96 | -162 |
DE | 67.7 | 74 | 123 | 261 |
EE | 4.8 | -3 | -64 | -178 |
EL | 107.5 | 106 | 147 | 255 |
ES | 43.2 | 25 | -16 | 72 |
FR | 66.8 | 70 | 120 | 239 |
IE | 27.6 | 10 | -18 | 31 |
IT | 106.4 | 110 | 142 | 261 |
CY | 70.3 | 63 | 77 | 249 |
LV | 11.9 | 6 | 1 | 29 |
LT | 18.7 | 17 | 23 | 77 |
LU | 6.2 | 10 | 88 | 268 |
HU | 58.4 | 79 | 189 | 493 |
MT | 74.7 | 73 | 78 | 79 |
NL | 52.9 | 37 | 9 | 47 |
AT | 62.9 | 56 | 42 | 63 |
PL | 42.5 | 56 | 45 | 40 |
PT | 63.9 | 79 | 192 | 528 |
SI | 29.1 | 27 | 67 | 274 |
SK | 34.5 | 31 | 40 | 134 |
FI | 41.1 | 18 | -37 | -42 |
SE | 50.3 | 32 | -21 | -41 |
UK | 42.8 | 48 | 100 | 239 |
EU12* | 70 | 67 | 87 | 196 |
EU25* | 63 | 61 | 79 | 180 |
Note: *Aggregates exclude Greece.
Source: Commission services.
On the basis of current policies, 11 countries will have a debt/GDP ratio above the 60% of GDP reference value by 2030 and by 2050; another 7 countries will have been added to the list of 'high-debt' countries, implying that more than two thirds of the Member States will be breaching the 60% threshold.
Graph II.2. Debt developments in the EU and the euro area 2005-2050
[pic] Note: Since long-term pension projections for Greece were not available in time for the completion of this report, the EU and Euro-area aggregates are calculated without Greece.
Source: Commission services.
Comparison with the results of the public finance sustainability analysis in the 2005/06 assessment round of Stability and Convergence programmes
The quantitative results in this report are to a large degree similar to those in the 2005/06 assessment round of SCPs. Yet there are two main sources of differences (see Graph. II.3).
First, the results of the common projections exercise were not available in time for the submission of the stability and convergence programmes. The national projections were therefore used in the assessment of the sustainability of public finances.[31] Some of the budgetary items covered by the Ageing Report were missing in the stability and convergence programmes, for health-care (ES, LU, HU and PL), long-term care (DE, EE, EL, ES, FR, CY, LU, HU, MT, NL, PL and SK), education (ES, FR, LU, HU, NL and SI) and unemployment benefits (DK, ES, FR, CY, LU, HU, NL, PL, SI, FI and UK).
Moreover, the drivers behind health-care and/or long-term care were sometimes different, leading to more dynamic health-care expenditure in the programmes than in the Ageing Report projections in a number of cases (BE, CZ, FR, IE, CY, NL, PT, SI, FI and SE) and in two cases to less dynamic health-care expenditure (EE and MT).
Finally, for two countries Cyprus and Hungary, labour productivity growth and real GDP growth were assumed to be substantially higher in the convergence programmes than in the Ageing Report, limiting the increase of age-related expenditure as a share of GDP (See Table II.5).
Second, for a number of countries, the 2005 fiscal outturns were better than estimated in the 2005/06 stability and convergence programmes, owing in most cases to better-than-expected tax receipts (see Table II.6). In particular, in the Czech Republic, Denmark, Estonia, Latvia, Lithuania, Slovakia and Sweden the government balance was at least 1% of GDP higher than expected in the SCPs, in nominal terms but also in structural terms according to the commonly agreed methodology for calculating output gaps. Yet, some factors, which are not related to the business cycle, could be of temporary nature and significant for some countries, such as volatile tax revenues related to oil/gas prices. This would call for prudence in terms of policy conclusions since such budgetary developments may not be of a permanent nature.
Table II.5 : Change in the age-related budgetary items (between last year of the programme and 2050)
Pension | Health care | Long-term care | Education | Unemployment benefits | Total age-related |
SCP | outturn | SCP | outturn |
BE | 0.0 | 0.1 | 0.0 | 0.1 |
CZ | -4.8 | -2.6 | -3.4 | -1.4 |
DK | 3.6 | 4.9 | 3.6 | 5.2 |
DE | -3.3 | -3.3 | -3.0 | -3.1 |
EE | 0.3 | 1.6 | 0.4 | 1.5 |
EL | -4.3 | -4.5 | -4.8 | -5.3 |
ES | 1.0 | 1.1 | 1.2 | 1.3 |
FR | -3.0 | -2.9 | -3.3 | -3.1 |
IE | 0.3 | 1.0 | 1.1 | 1.9 |
IT | -4.3 | -4.1 | -4.0 | -3.9 |
CY | -2.5 | -2.4 | -3.1 | -2.9 |
LV | -1.5 | 0.2 | -1.7 | -0.1 |
LT | -1.5 | -0.5 | -2.3 | -1.1 |
LU | -2.3 | -1.9 | -1.5 | -1.3 |
HU | -6.1 | -6.1 | -5.7 | -6.3 |
MT | -3.9 | -3.3 | -3.8 | -3.1 |
NL | -1.2 | -0.3 | 0.0 | 1.0 |
AT | -1.9 | -1.5 | -1.6 | -1.0 |
PL | -2.9 | -2.5 | -2.9 | -2.6 |
PT | -6.0 | -6.0 | -5.0 | -5.2 |
SI | -1.7 | -1.8 | -1.2 | -1.5 |
SK | -4.1 | -2.9 | -2.8 | -1.6 |
FI | 1.8 | 2.6 | 2.1 | 3.2 |
SE | 1.6 | 2.9 | 1.6 | 2.6 |
UK | -3.1 | -3.5 | -2.9 | -3.3 |
Source: 2005/06 updates of stability and convergence programmes, Commission services calculations, Commission services Spring 2006 economic forecasts.
Graph II.3: S2 indicator in the baseline scenario compared with the results of the 2005/06 SCPs assessment round and main source of differences
[pic]
Note: The graph compares
-  The results of the '2005' scenario of the assessment of the 2005/06 stability and convergence programme. In this scenario, it is assumed that the structural primary balance is stable at the 2005 level over the programme period and thereafter evolves in line with the projected change in age-related expenditure according to the stability/convergence programme.
-  The results presented in this chapter. It similarly assumes that the structural primary balan ce is stable at the 2005 level over the period up to 2010 and thereafter evolves in line with the projected change in age-related expenditure according to the Ageing Report in the years after 2010.
Source: Commission services.
Comparison of long-term pension projections
Table II.5 presents the change in pension expenditure as a share of GDP between 2005 and 2050 in consecutive projections: the common projection exercises in 2001 and 2006 - and Member States' projections as included in their stability and convergence programme updates.[32] It reveals that, for most countries, the change in pension expenditure as a share of GDP has been revised over time, sometimes significantly.
The revisions of projected changes in pension expenditure over the long-term are due to several factors, notably but not exclusively due to reforms of pension systems. The effects of pension reforms enacted since 2001 is noticeable in several countries (DE, EL, FR, IT, NL, AT, FI and SI). Except for Slovenia where the indexation of pension after retirement was made more generous for pensioners in 2005, reforms resulted in a smaller increase in pension expenditure.
However, other not policy-related changes also had significant impact on the projections, notably demographic assumptions (DK, ES, IE and PT), economic assumptions (LU, CY, HU and PL) or coverage of expenditure (inclusion of public sector employee in UK and LU, exclusion of quasi-mandatory scheme in LV and HU). Changes may be linked to new models (IE for public pension, LU regarding the treatment of cross-border workers) or also to new assumptions regarding pensions. This is the case for the United Kingdom, where indexation rules are not fixed in a long-term perspective and where the increase in pension expenditure in the 2005 CP is partly linked to a change in the assumptions regarding indexation. Finally, countries have also extended the period over which pensions are projected (e.g. FR and PL).
Table II.7 sums up the main reasons behind the change in the projections. It mainly focuses on the changes that had a large impact in the change in pension expenditure as a share of GDP. Smaller changes are therefore not explained. Moreover, one should not read the change in the projections from one year to the next as the result of one single factor (for example a pension reform) since it is sometimes difficult to disentangle the different factors at play (see the Ageing Report 2006, section 3.3.1). This comparison shows that the changes are in many cases related to policy changes or result from a better coverage of public pension expenditure, improved methodology or a longer period of projections. These changes increase the comparability between countries and improve the assessment of long-term sustainability of the public finances.
Some changes are however due to a different set of assumptions regarding demographic developments or the long-term economic outlook. It is interesting to note that such factors may have an impact on projections that are of the same magnitude as far-reaching pension reforms (i.e. a couple of points of GDP). It shows the crucial importance of using the common framework to ensure comparability of the projections and of the sustainability assessments in the context of the EU's multilateral budgetary surveillance.
Table II.7 Evolution of pension expenditure compared: EPC and SCP projections (as change in % of GDP between 2005-2005)
Common projections | Updates of the stability and convergence programmes | Common projections |
2001 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 |
*Change between 2005 and 2040; ** Change between 2002 and 2050; *** Change between 2005 and 2020.
Source: EPC report 2001, EPC report 2006, Stability and convergence programmes.

 Table II.8 Main factors with an impact on the pension projection results over time
Pension reform | Coverage | Demographic assumptions | Economic assumptions | Modelling |
Higher life expectancy | Higher labour productivity | Higher employment of older workers | Higher employment | Higher interest rate |
BE | 0.1 | -0.6 | -0.2 | 0.4 | 0.4 |
CZ | -0.1 | -0.8 | -0.5 | 0.4 | 0.8 |
DK | 0.1 | -0.6 | -0.2 | 0.4 | 0.6 |
DE | 0.1 | -0.5 | -0.2 | 0.3 | 0.3 |
EE | -0.2 | -0.7 | -0.5 | 0.3 | -0.3 |
EL | 0.0 | -0.4 | -0.2 | 0.2 | 0.6 |
ES | 0.0 | -0.5 | -0.3 | 0.3 | 0.4 |
FR | 0.0 | -0.6 | -0.3 | 0.4 | 0.5 |
IE | 0.0 | -0.7 | -0.4 | 0.4 | 0.2 |
IT | 0.0 | -0.4 | -0.2 | 0.2 | 0.3 |
CY | -0.1 | -0.4 | -0.2 | 0.2 | 0.0 |
LV | -0.3 | -0.8 | -0.6 | 0.2 | -0.5 |
LT | -0.2 | -0.5 | -0.4 | 0.2 | -0.4 |
LU | -0.1 | -0.7 | -0.3 | 0.4 | -1.4 |
HU | 0.0 | -0.6 | -0.5 | 0.3 | 0.2 |
MT | 0.1 | -0.5 | -0.6 | 0.3 | 0.2 |
NL | 0.0 | -0.4 | -0.2 | 0.2 | 0.4 |
AT | 0.1 | -0.5 | -0.2 | 0.3 | 0.5 |
PL | -0.1 | -0.6 | -0.4 | 0.3 | -0.4 |
PT | 0.1 | -0.5 | -0.2 | 0.3 | 0.8 |
SI | -0.2 | -0.6 | -0.5 | 0.2 | 0.8 |
SK | -0.1 | -0.7 | -0.5 | 0.3 | 0.4 |
FI | 0.0 | -0.5 | -0.3 | 0.3 | 0.3 |
SE | 0.0 | -0.6 | -0.3 | 0.4 | 0.9 |
UK | 0.3 | -0.8 | -0.1 | 0.6 | -0.1 |
EU25 | 0.1 | -0.6 | -0.2 | 0.4 | 0.3 |
EU12 | 0.1 | -0.5 | -0.2 | 0.3 | 0.4 |
Standard deviation | 0.1 | 0.1 | 0.1 | 0.1 | 0.5 |
Note: Results are given for the S2 indicator as a reference to the Ageing Report reference scenario which is used in the calculations of the indicators in Chapter I. Therefore the table shows the impact on S2 indicators that would result from using the alternative scenarios instead of the Ageing Report reference scenario. However, most scenarios have been designed as a reference to the pure ageing scenario, i.e. changing one hypothesis compared to the 'pure ageing' scenario. The differences versus the reference scenario therefore include the result of the variant (i.e. constant health-status) plus the assumptions made in the reference scenario (see Annex).
Source: Commission services.

 Table III.3. Change in the age-related budgetary items up to 2050 (% of GDP)[43]
Health care | Long-term care |
SCPs | AR | SCPs | AR |
BE | 1.9 | 1.2 | 1.1 | 0.9 |
CZ | 2.6 | 1.7 | 0.3 | 0.4 |
DK | 1.1 | 0.8 | 1.1 | 1.1 |
DE | 1.1 | 1.0 | : | 1.0 |
EE | -0.3 | 0.8 | : | 0.3 |
EL | 1.5 | 1.6 | : | : |
ES | : | 2.1 | : | 0.3 |
FR | 2.4 | 1.5 | : | 0.2 |
IE | 2.7 | 1.8 | 1.0 | 0.6 |
IT | 0.9 | 1.2 | 0.4 | 0.7 |
CY | 1.9 | 1.0 | : | : |
LV | 0.6 | 0.8 | 0.1 | 0.3 |
LT | 0.8 | 0.7 | 0.2 | 0.3 |
LU | : | 1.1 | : | 0.6 |
HU | : | 0.9 | : | 0.6 |
MT | 0.5 | 1.7 | : | 0.3 |
NL | 3.2 | 1.2 | : | 0.6 |
AT | 1.2 | 1.4 | 0.7 | 0.9 |
PL | : | 1.2 | : | 0.1 |
PT | 1.1 | 0.4 | 0.6 | 0.4 |
SI | 2.9 | 1.4 | 1.0 | 1.1 |
SK | 1.4 | 1.7 | : | 0.5 |
FI | 1.8 | 1.3 | 2.4 | 1.6 |
SE | 1.3 | 1.0 | 2.9 | 1.8 |
UK | 1.5 | 1.7 | 0.6 | 0.8 |
Source: Commission services.
A higher interest rate gives more weight to the current level of outstanding debt and less weight to future budgetary developments. While such a hypothesis of real interest rates (4% real interest rate) may look pessimistic in the future, it underlines possible short-term risks regarding the evolution of debt. Indeed, a higher interest rate/growth rate differential can not be excluded in the short/medium run. If such an outcome was to materialize, this would lead to a faster increase of debt in the medium-term, raising concerns regarding the sustainability of public finances even before taking into account the impact of ageing (the importance of debt level is addressed in Chapter IV.1).
Alternative scenarios for health-care and long-term care
Health-care
In addition to the uncertainties regarding the future demographic and economic outlook, there are also large uncertainties regarding the main drivers of health-care and their potential impact on the public finances. There has been an upward trend in health-care expenditure as a share of GDP in most Member States in the past, despite differences in the institutional arrangements and the health status prevailing in the different Member States.[44] At the same time, the increase in the old-age dependency ratio in the EU has been limited.[45] Indeed, whether the increase in life expectancy will result in longer years spent in good health or not, whether new technologies and medical progress will result in lower or higher cost are important questions that may receive ambiguous empirical answers and strongly influence the projections.
Such uncertainties led to the simulations of several alternative scenarios of the future evolution of health-care in the Ageing Report. The reference scenario chosen in the Ageing Report takes into account the results of two alternative scenarios (constant health and income elasticity) compared to the pure 'ageing' scenario.[46] The projections of this reference scenario are quite close to the ‘pure ageing’ one since the relieving impact of the better health status of citizens is compensated for by a higher income elasticity.
The sensitivity tests show that public spending on health is sensitive to changes in the health status of elderly citizens, in fact improved health status halve the projected increase in health-care expenditure. This points to the possible budgetary alleviating impact of policies aiming at improving the health of elderly citizens (see Table III.2). Health-care expenditure is also very sensitive to even relatively modest changes in the assumptions on income elasticity of demand, and also on the evolution of unit costs.[47] Increased demand for health-care services could occur due to higher pressure for a better quality of health services in the face of rising per capita income. More dynamic spending could also occur if prices within the health sector, mostly wages of skilled workers and pharmaceuticals, were to grow faster than in the economy as a whole. In particular, the net impact of technological progress on health-care spending is ambiguous: while it will reduce unit cost for existing cures, it will increase the supply of treatments which can induce higher demand for health-care services.
Table III.4. Impact on the sustainability indicator of alternative long-term care assumptions (deviation from S2 in % points of GDP)
pure ageing | constant disability | increase formal care | benefit indexed on price |
BE | 0.2 | -0.2 | 0.4 | : |
CZ | 0.1 | -0.1 | 0.4 | : |
DK | 0.3 | -0.3 | : | : |
DE | 0.2 | -0.2 | 0.6 | -0.7 |
EE | 0.1 | -0.1 | 0.2 | : |
EL | : | : | : | : |
ES | 0.0 | 0.0 | 0.6 | : |
FR | 0.1 | -0.1 | 0.4 | : |
IE | 0.1 | -0.1 | 0.3 | : |
IT | 0.1 | -0.1 | 0.8 | : |
CY | : | : | : | : |
LV | 0.1 | -0.1 | 1.7 | : |
LT | 0.1 | -0.1 | 0.5 | : |
LU | 0.2 | -0.2 | 0.6 | : |
HU | 0.1 | -0.1 | 0.6 | : |
MT | 0.1 | -0.1 | 0.1 | : |
NL | 0.1 | -0.1 | 1.0 | : |
AT | 0.0 | 0.0 | : | : |
PL | 0.0 | 0.0 | 0.2 | : |
PT | 0.1 | -0.1 | 0.4 | : |
SI | 0.2 | -0.2 | 1.1 | : |
SK | 0.1 | -0.1 | 0.3 | : |
FI | 0.4 | -0.4 | 0.9 | : |
SE | 0.6 | -0.6 | 1.1 | : |
UK | 0.2 | -0.2 | 1.5 | : |
EU25 | 0.1 | -0.1 | 0.7 |
EU12 | 0.1 | -0.1 | 0.6 |
Standard deviation | 0.1 | 0.1 | 0.4 |
Source: Commission services. 

 Moreover, many of these alternative scenarios (except the unit-cost scenario) would lead to a relatively uniform impact across countries. However, it cannot be excluded that if the institutional features of the public health-care systems in the Member States[48] were explicitly modelled, a larger diversity across Member States might be present (e.g. as regards effectiveness of aggregate budgetary control measures, micro incentives for patients and health-care professionals favouring rational resource use, etc.).
As shown in Table III.3, Member States reported in the SCPs in most cases more dynamic health-care expenditure in their programmes than in the Ageing Report baseline projections (BE, CZ, FR, IE, CY, NL, PT, SI, FI and SE).[49] This is also the case for long-term care in the case of Ireland, Finland and Sweden. This is mainly explained by different assumptions concerning the drivers of spending increases in national projections compared with the reference scenario in the Ageing Report.[50] For example, in several of the national projections it is assumed that wages in the health-care/long-term care sectors increase faster than assumed in the Ageing Report. When countries establish their fiscal targets (e.g. in the context of the new SGP), they may choose to use a more prudent approach regarding the future evolution of health-care, and also long-term care, to prepare themselves for higher provision of public care. Such alternative (and more dynamic) scenarios are more appropriate to understand the fiscal objectives that countries have set for themselves.
Long-term care
In the baseline scenario, long-term care projections show a larger set of outcomes due to a large diversity in the current public provision on long-term care in the EU (which ranges today from 0.1% of GDP in Poland to 3.8% of GDP in SE). The current level of public spending on long-term care as a share of GDP has a strong impact on the projected future spending. As a result, alternative assumptions will show a larger diversity across Member States for long-term care than for health care.
Moreover, in contrast with sensitivity tests on pensions or health care, there is a scenario which departs from the “no-policy change" assumption. The "increase in formal care" scenario assumes a 1% decrease in the number of persons receiving informal care up to 2020, with half of the additional persons receiving formal care going to institutions and the other half receiving formal care at home (see Table III.4). This would increase the sustainability gap by more than ½% of GDP in the EU. Such a change in policy is not considered in the reference scenario, following the no-policy change approach of the Ageing Report. However, the scenario points to the additional pressure on public finances that could result from an increasing gap between the need of formal care and services provided by the general government. In particular, Member States with low levels of formal care provision at present – and correspondingly low levels of public spending – will also experience a large increase in the projected number of older persons in need of care. Pressures may therefore emerge in the future for policy changes to increase formal care provision if countries would rely less on informal care. Such a scenario cannot be excluded in view of the rather large projected increase in labour force participation, especially among women. Employment rates of women are projected to increase by 10 percentage points between 2003 and 2050 on average in the EU, and by more than 15 percentage points in Spain, Malta and Poland.
Finally, it should also be noted that under the existing rules in Germany, all long-term care benefits are fixed by law. Keeping them constant in nominal terms – with no indexation at all – cannot be considered as meaningful of constant policy approach in a long-term analysis of this kind. Thus an alternative scenario was run assuming an indexation on price. Calculations following this approach would lead to a constant share of long-term care in GDP and would reduce the sustainability gap for Germany by 0.7% of GDP. However, if unit costs of supplying long-term care increase more than general price level of the economy, this could lead to an increasing gap between needs and provisions of public long-term care.
Illustrating the sustainability impact of attaining the medium-term objective
The quantitative indicators
A vast majority of Member States’ budgetary plans involves consolidating the budgetary position over the medium-term. This is required by the Stability and Growth Pact for countries which have not yet reached their medium-term objective (MTO) and by the budgetary pressures arising from ageing populations in the EU over the coming decades. Reconciling this policy challenge with the medium-term budgetary policy formulation process was an important factor in the reform of the Stability and Growth Pact in 2005. As a part of the new SGP, MTOs that reflect country-specific characteristics were introduced.[51]
In order to illustrate to what extent the in most cases budgetary consolidation can contribute to reduce risks to public finance sustainability a scenario is run in which it is assumed that all Member States attain their MTOs in 2010. The MTO is defined as the structural government balance. For the purposes of long-term public finance sustainability analysis, the structural primary balance underlying the MTO in 2010 is required. The structural primary balance in 2010 is calculated with the following assumptions:
-  the general government balance is assumed to converge in a linear fashion towards the MTO in 2010 and the cyclical impact is assumed to be zero by 2010;
-  the interest rate on debt in 2010 is assumed to be the implicit interest rate on debt in the last year of the stability/convergence programme of the country concerned.[52]
Interpreting the MTO scenario
The MTO scenario is essentially a sensitivity test related to the initial budgetary position.
Box III.1. The 'cost of delay' indicator The 'cost of a delay' indicator shows the increase in the sustainability indicators that would result from a delay of five years in implementing budgetary consolidation compared to the baseline. As shown in Graph III.1, it would result in an increase of the sustainability indicators for the EU of around 0.3 p.p. as measured by the S2 indicator and of around 0.4 p.p. of GDP for the S1 indicator. The cost of a delay is proportional to the size of the sustainability gap and is therefore significantly larger for countries with large sustainability gaps (notably Hungary, Portugal and Slovenia as regards the S2 indicator), underlying the urgency in implementing reforms in those countries. First, the cost of a delay for the EU as a whole may look relatively small: this is largely because countries which do not implement budgetary consolidation during the next five years have a long period of time to reimburse additional interest on debt (up to infinity in the case of S2 and up to 2050 in the case of S1). However, this does not mean that reforms can be indefinitely postponed; the size of the necessary adjustment increases over time, making it more costly to implement reforms in the future than today. Graph III.1. The cost of delay (in % of GDP) [pic] Source: Commission services. |

 First, it does not mean that the Commission expects all countries to reach the MTO exactly in 2010; some countries had already attained their MTO in 2005 while some might reach it only after 2010. About half of the Member States do not reach their MTO by the end of the stability/convergence programme period, which in most cases is in 2008 and in general a target year beyond the last year of the programme is not given.
Second, the interpretation of this scenario will depend on whether the country is above or below its MTO. For countries which have not yet reached their MTO, it illustrates how much consolidating public finances can contribute to the long-term sustainability of public finances. By contrast, for countries who are already above their MTO in 2005, the MTO scenario implies a fiscal loosening and thus a negative impact on sustainability.
Third, for countries where the debt/GDP ratio is expected to remain broadly unchanged over the medium term (i.e. up to 2010), the date when the MTO is reached, whether it is 2005 or 2010, implies a similar underlying primary balance. However, some countries with a rapidly declining debt over the next years, notably Belgium and Denmark, can expect a significant reduction of interest expenditure. Therefore, keeping the MTO target for the deficit implies a lower primary balance over the medium-term than today and therefore a higher sustainability gap.
Finally, it is a possible sensitivity test of the impact of the changes in the budgetary position on the sustainability indicators. It is different from the 'programme' scenario which is carried out in the assessment of the stability and convergence programmes. In the 'programme' scenario, it is assumed that the public finances over the medium-term evolve as planned in the stability/convergence programme and the last year of the programme is the starting point for the long-term sustainability projections.[53] Another sensitivity test regarding budgetary consolidation is the cost of a delay indicator which estimates the change in the sustainability indicators that would result from postponing the budgetary adjustment (see Box III.1).
Table III.5. Government balances in 2005 and the MTOs compared (% of GDP)
balance in 2005 | Primary | in the | in 2010 |
SCP 2005/06 | outturn | Balance 2005 | SCPs | used in the MTO scenario |
S1 | S2 |
Total | IBP | DR | LTC | Total | IBP | LTC |
debt |
2005 | 2010 | 2030 | 2050 |
BE | 93.3 | 74 | 52 | 129 |
CZ | 30.5 | 30 | 43 | 188 |
DK | 35.8 | 18 | 23 | 98 |
DE | 67.7 | 64 | 37 | 65 |
EE | 4.8 | 0 | -25 | -82 |
EL* | 107.5 | 90 | 18 | -56 |
ES | 43.2 | 30 | 33 | 198 |
FR | 66.8 | 60 | 41 | 66 |
IE | 27.6 | 17 | 37 | 157 |
IT | 106.4 | 97 | 32 | 1 |
CY | 70.3 | 57 | 42 | 172 |
LV | 11.9 | 9 | 26 | 92 |
LT | 18.7 | 16 | 22 | 76 |
LU | 6.2 | 10 | 74 | 240 |
HU | 58.4 | 61 | 51 | 155 |
MT | 74.7 | 65 | 16 | -58 |
NL | 52.9 | 46 | 70 | 176 |
AT | 62.9 | 54 | 23 | 18 |
PL | 42.5 | 45 | -33 | -163 |
PT | 63.9 | 65 | 64 | 208 |
SI | 29.1 | 27 | 65 | 270 |
SK | 34.5 | 31 | 16 | 66 |
FI | 41.1 | 25 | 26 | 96 |
SE | 50.3 | 34 | -3 | -1 |
UK | 42.8 | 42 | 44 | 114 |
EU12* | 70 | 62 | 38 | 83 |
EU25* | 63 | 55 | 33 | 76 |
Note: * No pension projections were available for Greece and the change in the debt/GDP ratio is therefore underestimated in the case of Greece. Pension expenditure was projected to rise between 2005 and 2050 by 12.4% of GDP in the 2001 common projections exercise and 10.2% in the 2002 update of the Greek stability programme. The aggregate results for the European Union (EU25) and the Euro-area (EU12) exclude Greece.
Source: Commission services.
Conclusions
The results of the indicators are sensitive to the different hypotheses used in the calculations and as such the exact level of the sustainability gap is subject to some uncertainty, notably as regards the evolution of health-care expenditure which depends on the assumptions made. In particular, a low sustainability gap does not suggest that there is no risk at all to the long-term sustainability of public finances; rather, it suggests that the challenges and the size of the adjustment are smaller than in other EU countries. The sensitivity of the indicators should be put in perspective with the large diversity shown by the indicators in the EU (ranging from -3% of GDP to 10% of GDP in the baseline scenario). In particular, large sustainability gaps are likely to remain so even under alternative and more favourable hypothesis and therefore can be considered robust enough to signal large fiscal imbalances.
Moreover, budgetary consolidation over the medium-term can very efficiently limit the public finance sustainability challenge over the long-term; a significant part of the sustainability risks would be reduced if countries were to reach the medium-term objectives for the government finances that they have set for themselves.
In addition, public spending on health-care is sensitive to the health status of elderly citizens. This suggests that policies geared towards increasing the health status of elderly persons can result in non-negligible budgetary savings.
Besides, further pressures on government expenditure on long-term care cannot be excluded in the future since there may be an increasing gap between the need for formal care and the services provided by the public sector, notably in countries where the current coverage is limited.
Finally, the sensitivity tests also show that changing the underlying assumptions does not necessarily have a uniform impact across EU countries; for example, some public pension schemes are more resilient than others with respect to an increase in life expectancy.
Chapter IV
Qualitative factors
Summary
The sustainability indicators are indispensable tools for assessing the long-term sustainability of public finances but other factors are also taken into account to reach to an overall assessment.
Firstly, while the sustainability indicators already include information on the current level of the debt, they do not incorporate all the specific risks faced by countries with a large initial level of debt. For example, high-debt countries are more vulnerable to negative growth rate/interest rate shocks and have to maintain high primary surpluses for a prolonged period of time, which might be difficult to achieve in view of competing budgetary pressures. Countries which have a high current level of gross debt, above the 60% of GDP reference value, need to ensure its steady reduction. The current level of gross debt is therefore an important factor when reaching an overall assessment of the risks to the long-term sustainability of public finances.
Moreover, the ratio of the average pension and the average wage in the economy – the so-ca lled benefit ratio – is projected to decrease substantially in some EU countries. While contributing positively to public finances sustainability, such a decrease may raise concerns about the adequacy of public pensions that could translate into pressure for higher public spending. In this context, the risks to public finances will crucially depend on the reaction of individuals regarding their future retirement arrangements: accept a lower pension, work longer or increase their savings. Those individual choices will have very different effects on public expenditure and revenues. In that respect, the question of information current and future pensioners have regarding their future rights is central to ensure that current workers are making appropriate choices for the level of their individual savings in view of the planned length of their working lives and the level of their pension. The success of reforms aiming at increasing the retirement age is also crucial.
To date, no common projections of government revenue have been made at the EU level. Yet, demographic changes may have also an impact on the size and sources of tax revenues; and consequently public revenue developments may have an impact on the sustainability of public finances. However, except in a few cases where large country-specific trends can be identified (notably the tax treatment of private pensions), the impact of revenue projections is more limited, leading to a limited impact on the assessment of the sustainability of public finances. In addition, a more consistent way of treating property income could lead to a higher sustainability gap compared to the baseline scenario, notably in the few countries where property income is relatively large.
Stock-flow adjustments (SFAs) are supposed to cancel out over the medium term in the projections; i.e. the debt level is assumed to be driven only by the general government deficit. Given the level of SFAs in some countries in the recent past, this may not be the case. If maintained over the long-term, persistent debt-increasing SFAs may imply further risks on long-term sustainability.
The level of current tax ratio has no impact on the calculations of the sustainability indicators. Nevertheless, the current level of tax burden can be a relevant element in the analysis of the long-term sustainability of public finances. Namely, in the light of the projected increases in the age-related expenditures in the long term, the information regarding the current tax burden provides an important indicator of a government's capacity for a direct increase in revenues.
Finally, the sustainability indicators include explicit debt and implicit liabilities but do not include information on contingent liabilities which may increase pressure on public finances if they materialize. The impact of contingent liabilities although rather limited on the sustainability indicators, could be large on debt. At this stage the lack of data prevents a systematic use of this factor in the sustainability analysis.
Government debt and the long-term sustainability of public finances
In the analysis about the long-term sustainability of public finances, the concept of debt-to-GDP ratio plays a central role. A country is often considered to be in an unsustainable situation if the debt-to-GDP ratio reaches a level beyond which the country faces difficulties in issuing new debt.[55] Since this maximum level of debt, beyond which it is considered as unsustainable, is not defined ex-ante, sustainability is measured by looking at the dynamics over time, in particular whether debt is stable, declining or increasing.[56] Besides being already integrated in the long-term debt projections on the basis of which the sustainability indicators are calculated, the current debt level provides additional information on the sustainability of public finances, in particular in the light of the following stylised facts:
-  High debt countries are more vulnerable to negative interest rate/growth rate shocks through the increased interest burden or through a worsening in the underlying budget balance. If such shocks were to materialize in the near future, they could lead to a rapid accumulation of public debt and question the vulnerability of public finances over the medium term. Moreover, high levels of debt may lead to higher interest rates as investors might require higher premia thus increasing further the risks to public finance sustainability (see Chapter III.1 for the impact of a higher interest rate on the sustainability indicators).
-  In addition, high debt countries need to maintain primary surpluses over a long period of time in order to reduce debt. This may, however, be particularly difficult in the view of competing budgetary pressures as interest expenditures represent a substantial burden, requiring the primary surplus to be even higher if the debt is to be reduced successfully.
-  Sustainability indicators do not take into account any information on debt dynamics in the recent past. An analysis of debt developments over the period prior to the starting point contributes to qualifying the risks to sustainability in relation with the likelihood of realisation of the planned government debt path over the medium term. This is particularly relevant for cases where government debt has been increasing rapidly even if from relatively moderate levels, where it has been relatively high and increasing or has not been declining at a satisfactory pace. [57]
-  In the context of the EU fiscal framework, Member States are obliged to avoid excessive budgetary deficits and to comply with budgetary discipline by respecting two criteria. Besides the deficit criterion, debt to GDP ratio should not exceed a reference value of 60%, unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace; as defined in Article 104 of the Treaty and in the Protocol on the EDP annexed to the Treaty. Assessment of the long-term sustainability of public finances in the context of the EU budgetary surveillance qualifies the situation with regards to respect of the Treaty reference value for government debt.
For these reasons, countries which have a high current level of gross debt, above the 60% of GDP reference value, need to ensure its steady reduction. The current level of gross debt is therefore an important factor when reaching an overall assessment of the risks to the long-term sustainability of public finances.
Recent dynamics government debt in the EU Member States
Following the resolute budgetary consolidation process in the face of meeting the Maastricht criteria for entering the euro-area, the government debt of the euro-area Member States declined from 73.9% of GDP in 1996 to 68.1% of GDP in 2002. Since then, however, amid the prolonged period of slow growth as well as lack of consolidation effort in some of the large Member States, the government debt in the euro area has been increasing again; reaching 70.8% of GDP in 2005 (see Table IV.1).
Over the period, Germany, France and Portugal joined the group of the euro area countries characterised by government debt above 60% of GDP already in 2000 (Belgium, Greece, Italy and Austria). Particularly worrying is the situation in Greece and Italy, where debt persists at the levels higher than 100% of GDP. 
 Table IV.1. Gross government debt 2000-2007 (% of GDP)
Gross government debt | Change in gross government debt |
In 2005 | Evolution compared to 2005 |
Without the funded part of the mandatory schemes | With the funded part of the mandatory schemes |
2030 | 2050 | 2030 | 2050/ |
BE | 17.8 | -2% | -8% |
CZ | 15.5 | -16% | -9% |
DK | 20.1 | -4% | -5% |
DE | 18.0 | -18% | -26% |
EE | 11.4 | -37% | -54% | -29% | -27% |
EL | NA | NA | NA |
ES | 17.5 | 9% | -2% |
FR | 24.6 | -18% | -23% |
IE* | 14.3 | 16% | 10% |
IT | 20.1 | -12% | -31% |
CY | 25.6 | 0% | 20% |
LV | 11.0 | -17% | -35% | -11% | -3% |
LT | 7.6 | 12% | 0% | 17% | 24% |
LU | 23.8 | 12% | 18% |
HU | 13.8 | 14% | 17% | 18% | 39% |
MT | 18.2 | -17% | -44% |
NL | 18.8 | -4% | -4% |
AT | 21.1 | -10% | -28% |
PL | 18.6 | -23% | -51% | -21% | -43% |
PT | 18.9 | -13% | -18% |
SI | 18.6 | -7% | -7% |
SK | 13.4 | -15% | -34% | -7% | -17% |
FI | 19.1 | -3% | -6% |
SE* | 20.9 | -25% | -31% | -21% | -24% |
UK* | 16.4 | -14% | -22% |
Note: The public benefit ratio relates to total public pensions (survivor, old-age and early pensions and disability schemes) except for two countries. The public benefit ratio in the UK relates to old-age and early pensions due to data availability and in Sweden, the public benefit ratio exclude premium pensions, which are included in the pension projections of the Ageing Report as public expenditure (see table 3-16 of the Ageing Report). In addition to this benefit ratio, an additional benefit ratio is presented including the mandatory private schemes for the countries which implemented such a reform (SE, EE, HU, LV, LT, PL and SK). Finally, the increase in the benefit ratio for Ireland is calculated with regard to 2004, since the benefit ratio in 2005 is significantly lower than in the years before or after. The level of the benefit ratio in 2005 is the same, whether the funded part of the mandatory scheme is taken into account or not since the introduction of such schemes is still very recent.
Source: EPC/European Commission Ageing Report (2006).
Box IV.1. Relative level of pensions, replacement rates and the benefit ratio
Two types of forward-looking indicators are available to measure the future relative level of pensions:
-  The benefit ratio defined as the average pension per GDP per worker: it is derived from the long-term projections of the Ageing Report and is therefore a macroeconomic indicator;
-  The replacement rate, which is defined as the first pension compared to the last wage: it gives an understandable measure of the pension an individual will receive. The replacement rate is specific to each individual and depends on a large number of factors (number of years worked, wage-profile, period of unemployment or sick-leave, sometimes the number of children or the gender…). Theoretical replacements rates are therefore usually calculated for a "representative" individual or a set of "representative" individuals. Such replacement rates have been analysed by the SPC (see Synthesis report on adequate and sustainable pensions*).
The evolution of the benefit ratio and the replacement rate are linked, since a reduction of the replacement rate at retirement will translate into a reduction of the benefit ratio ceteris paribus . Due to their nature, they can however evolve differently. The benefit ratio reflects average changes, while the theoretical replacement rate provides changes for typical situations and can thus identify different effects**.
First, the benefit ratio in a given year is the average of pensions received by all pensioners currently alive and as such is an average of the replacement rates of numerous generations. It therefore depends on the past relative level of the pension system and on indexation of pensions after retirement, which has no direct impact on the replacement rate at retirement but affects directly the benefit ratio.
Second, replacement rates, except when a large set of representative individuals are available, generally do not cover all possible schemes (e.g. private sector employees, civil servants…) and all redistributive features that can improve the pension rights of an individual through different features of social security (e.g. for children, periods of unemployment …). The benefit ratio normally takes into account all different schemes and models the effect of such benefits.
Finally, the benefit ratio is usually derived from real careers, i.e. more or less complete, with contribution records changing over time. The benefit ratio will reflect long-term trends in the labour market. On the one hand, later entrance into the labour market or longer periods of unemployment will result in a shorter contribution period and therefore, lower benefits over time. On the other hand, rising female labour force participation, better employment record or maturing pension systems will increase the benefit ratio even with unchanged pension rules.
* http://ec.europa.eu/employment_social/social_protection/pensions_en.htm#adequacy
** See 'Current and prospective theoretical pension replacement rates', SPC (2006) http://ec.europa.eu/employment_social/social_protection/docs/isg_repl_rates_en.pdf
The evolution of the benefit ratio over time gives indications on the evolution of the relative level of public pension under the assumptions commonly agreed in the Ageing Report.[61] However, the extent to which a decline in the benefit ratio presents risks to public finances (IV.2.1.) will first depend on the distribution of pension entitlements across population, notably to assess if it implies higher poverty risks for older people in the future. The Ageing Report does not include such projections of the distribution of pension entitlements and alternative indicators have to be used, e.g. the current level of public expenditure and the current distribution of pensions (IV.2.2). The risks to public finances will also depend on the ability of workers to actually earn additional retirement income either through longer working lives or higher private savings. The decrease in the benefit ratio must be assessed in comparison with the prospective coverage of private pensions (IV.2.3) and the current and projected employment rates of older workers (IV.2.4).
Decrease in the relative level of pensions and risks to public finances
Main risks for public finances
Reducing the relative level of public pensions may reveal an overall preference for longer time spent in retirement over higher pensions. It can result from reducing the accrual value of one working year, introducing more links between the contribution record and the level of the pension, or more complex mechanisms, notably from changing the indexation rules or moving to a completely new system. Moreover, the convergence of different pension schemes, with different levels of replacement rates (e.g. between civil servants schemes and social security schemes) may happen towards the less favourable case for the pensioner. Pension reforms can also reduce or abolish some benefits or bonuses which are no longer considered as fair (e.g. accrued pension rights for years spent in university). All these factors can lead to an overall reduction of the benefit ratio.
The convergence between different pension schemes or the reduction of some benefits may result in a lower benefit ratio.[62] Yet, if those changes, whose redistributive impacts are quite clear at the time they are enacted, have been considered in general as fair, they should not trigger specific demands for those categories later. By contrast, if low pensions are insufficient, this may induce further risk of poverty for older people and therefore translate into pressures to increase public expenditure through, for example, the improvement of minimum pensions or an increase in benefits in kind to older people.
Many pension reforms are designed in such way that the decrease in the relative level of the public pensions can be compensated at the individual level by increasing the age of retirement and/or by increasing private savings. Therefore the risks to public finances associated with a decrease in the relative level of public pensions cannot be assessed separately from the capacity of workers to effectively increase their retirement age and/or build up private savings.
An increase in the effective retirement age will be very difficult to achieve if there are no financial incentives for workers to postpone their retirement age. Increasing the number of years to be entitled to a "full" pension, linking the level of the pension to life expectancy or increasing financial penalties for early retirement, aim at increasing the retirement age but it may also result in lower pensions if workers do not work longer. As an illustration, in Sweden, the pension depends on the unisex life expectancy at the specific date of retirement. The increase in life expectancy between today and 2050 (a little more than 3 years) will decrease pensions by 13% if the worker retires in 2050 at the same age as today. Simulations show that extending one's working life by 2/3 of the increase in life expectancy is enough to compensate for the decrease in the replacement rate.[63]
Most pension reforms aim at giving individuals the opportunity to 'choose' a higher pension or longer time spent in retirement. However, if the postponement of the retirement age does not result in a sufficiently large increase in pension entitlements, workers may simply not postpone their retirement age (supply-side barriers). Moreover, an increase in the effective retirement age may also fail if other barriers to old-age employment, if any, are not reduced (demand-side barriers).[64] Indeed, the early retirement or the early withdrawal from the labour market may result in lower pensions but if this is not driven by the workers' choice and is a consequence of obstacles limiting the work activity of older workers, this may lead to budgetary pressure.
A decrease in the relative level of public pensions can also be partly compensated by other types of pensions, whether they are occupational or supplementary pensions (i.e. non-public). A higher coverage of private pensions can diversify the risks and increase the returns on savings. However, a stronger reliance on private savings may also lead to several types of risks for public finances. This is the case if net returns from private pensions turn out to be lower than expected for example if returns on assets are low or administrative costs are high. The general government may have to compensate part of the shortfall in the revenue of elderly citizens (contingent liabilities), particularly so if it concerns low-income pensioners since a shortfall of pensions may have a more dramatic impact for that group.[65] The level of private pension arrangements will depend on the extent to which occupational private pensions are binding for employers and employees and on the level of information workers currently have regarding the evolution of their future pension rights. For example, current contributions to private schemes may be too low, if workers underestimate their need for savings. More information on existing tax-incentives and/or larger tax incentives and/or promoting automatic enrolment to private schemes may be needed.[66] If those contributions are tax deductible, it will reduce public revenue at the time workers start to increase their contributions to the private schemes.
Assessing risks
The different types of risks discussed above are difficult to assess separately. Comprehensive pension reforms are usually designed to achieve several objectives at the same time: (i) contain the relative level of pensions; (ii) increase the effective age of retirement; and, (iii) promote private savings. Such broad reforms aim at giving a wider choice to the individual as regards his/her replacement rate (from both public and private schemes), his/her contribution rate (including private savings) and his/her retirement age. The impact on public finance of such reforms will therefore ultimately depend on the effective individual choices. Namely, the increase in the retirement age leads to higher tax revenue and lower pension expenditure whereas an increase in private savings reduces public revenue when individuals start to build up their private pensions.[67] Yet those choices are difficult to anticipate. The Ageing Report pension projections assume, explicitly or implicitly, certain behaviour of individuals in the future, notably regarding the choice of the retirement age. The evolution of the benefit ratio in the projections cannot be assessed separately from the hypothesis in the projections regarding the retirement age. Namely, it cannot be excluded that workers could postpone their retirement age more than it is currently projected notably if the relative level of their pension is significantly reduced.
Moreover, only a full distribution of public and private pensions across income groups and generations that takes into account the large redistributive effects due to enacted reforms and the impact of past trends in the labour market could give a precise picture of the risks to public finances. This point can be illustrated by the following example. Many countries that project a reduction in the benefit ratio have reinforced the link between the effective contribution record and the level of the pension.[68] This is usually less favourable for pensioners with incomplete careers or steep wage-profile than for pensioners with complete careers and rather flat wage-profile. For low-income pensioners with incomplete careers, the risks to public finances will depend on whether other redistributive features built in the system (bonuses for child-care, unemployment…) and the lengthening of careers, notably of women, will be sufficient to avoid an increase in the old-age poverty rate. For high-income pensioners e.g. with steep wage-profile, risks for public finances will depend on whether they are currently saving a significant part of their income.
Given that there is no such projection of the distributions of pensions, the analysis must draw on alternative indicators, notably:
-  the current level of pension expenditure and the current distribution of pension rights (relative income of older people, poverty rates);
-  the prospective coverage of private pensions;
-  the current and projected employment rates of older workers.
The following sections will focus on the 12 countries that project a substantial decrease (around 20% or more) in the public benefit ratio (DE, FR, AT, IT, PT, SE, UK, EE, LV, PL, SK and MT).
The current level of public and private pension expenditure and the current distribution of pensions
First, the evolution of the benefit ratio can be compared to the actual relative level of current pensions. Countries that project a large decrease in the public benefit ratio can be grouped in four categories: first, depending on the current level of public expenditure and second, on the coverage of private pensions.
Table IV.3. Coverage of current pension expenditure for the 12 Member States
Current coverage of privates pensions |
Current level of public pension expenditure | Traditionally low | Traditionally high |
Low (around 7% of GDP) | EE, LV, SK, MT | UK |
High (between 11% and 14% of GDP) | DE, FR, IT, AT, PT, PL | SE |
Source: Commission services.
In DE, FR, IT, AT, PT and PL current pensions come essentially from the public PAYG. The high level of public expenditure may be in some cases due to a low retirement age but is usually linked to relatively generous public pension scheme at present; indeed, the median income of people aged 65+ is close to those aged 0-64 (AT, DE, FR and IT) or even higher in some cases (PL).[69] For those six countries, the coverage of private pensions is traditionally more limited: current assets held by occupational or individual schemes are 12% of GDP in PT, around 3%/4% in FR, DE, AT and IT and very limited in Poland (see Table IV.3). Sweden has the same type of coverage of public pensions but occupational and supplementary pensions have traditionally played a greater role, with a large coverage of individuals (90%) and large assets in occupational and individual schemes (around 60% of GDP).[70]
Box IV.2. Impact of indexation rule after retirement
Rules regarding the indexation of pensions after retirement age do not impact the replacement rate (at retirement) but impacts the relative purchasing power of retirees after retirement and therefore the benefit ratio.* The question of indexation after retirement is essentially about the relative purchasing power of older pensioners compared to the pensioners that have just retired. Since wages are increasing over time, new pensions - which are (at least partly) earnings-related - increase in line with wages so, with unchanged replacement rate at retirement, new pensioners will be richer than older ones, whose pensions are only indexed on price.** If pensions after retirement are not fully indexed on wages, the relative purchasing power of very old retirees relative to the working-age population or younger retirees will decrease over time. These types of indexation rules may imply an increasing number of poor people among oldest generations, since the poverty rate is not defined in "real terms" but relative to the overall income of the economy, more precisely as the share of people whose equivalised disposable income is lower than a fraction of the median equivalised disposable income in the country, (for a definition of poverty rate, see technical annex of Adequate and Sustainable Pensions, SPC 2006).
Such indexation rules range from close to prices (IT, FR, AT, PT, UK, PL and MT) to halfway between price and wage sum (EE, LV and SK). For the other two countries, indexation is primarily on wages. In the case of Sweden, it is wage indexed at the aggregate level, but for the individual there is a front-loading involving an increase of 1.6% on the accumulated pension capital at the time of retirement and a respective reduction of the increase in subsequent years (e.g. if real wages and salaries increase by 1.6%, then the pension will rise at the same rate as inflation. In Germany, indexation will be reduced whenever the contribution rate rises (Riesler factor) or the dependency ratio deteriorates (Sustainability factor).*** It is worth noting that indexation after retirement does not increase as fast as wage for all the countries concerned.
* More precisely, in the case of earnings-related schemes, the evolution of the benefit ratio mainly depends on when the change of indexation has occurred. For example, in the case of indexation of pensions on prices, the relative purchasing power of retirees compared to the rest of the population will decrease over time at the individual level but this is compensated for at the aggregate level first because new pensions are higher and second because pensions that are no longer paid (usually of the oldest retirees) are on average lower. By contrast, if the rule has been changed recently (for example changed from wage to price in the case of Austria as for 2006) this will decrease the benefit ratio up to the point that the new indexation rule has reached its steady state.
** However pension reforms typically change replacement rates of new retirees over time with long transition periods, thus reducing the gap between the level of pensions between new and old retirees. It should be noted that, in some countries e.g. Germany, the level of the pension depends on the level of the "pension point" which is the same for new and older retirees. Therefore, an indexation of the pension point below wage will apply to all retirees and will not affect the relative level of pensions between young and retirees.
*** Dependency ratio is defined here as the ratio between the number of pensioners and the number of contributors.
The other five countries currently spend around 7% of their GDP in public pensions. It concerns four new Member states (EE, LV, SK and MT) where the coverage of private occupational and supplementary pensions is recent and rather limited, apart from the mandatory switch to defined contribution pension schemes. On the other hand, as DK and the NL, the UK has relied traditionally more on private savings: current assets held in occupational and individual schemes amounts to around 100% of GDP. Yet, the current coverage of supplementary pension schemes is around 50% (compared to more than 90% in DK and the NL).
The information provided by the current level of pension expenditure can also be completed with additional information regarding the distribution of income across old people, notably the current poverty rate.[71] The income of elderly citizens does not exclusively come from public pensions but it gives strong indications on the contribution of the pension schemes to provide elderly citizens with sufficient income and to prevent old-age poverty. In EE, IT, LV, PL and SK the poverty rate of people aged 65+ is lower than for the rest of the population despite sometimes a relative small public spending.[72] It is close or slightly higher in DE, FR and SE and is larger in UK, PT, AT and MT. This relates to the situation in 2003 and does not take into account recent reforms. Besides, the current poverty rate reflects past pensions and may give limited guidance concerning the evolution of the distribution of pensions in the future, though it gives an indication of the current situation.[73] Yet, the combined effect of more actuarial neutrality (which notably penalises relatively short careers) and of indexation of pensions that does not follow the evolution of wages (see Box IV.2) may induce higher poverty risks for the low-income pensioners.
Future coverage of private occupational and voluntary pensions
The focus has been so far on public pensions and the private part of the mandatory schemes but the revenue of pensioners can be completed by other types of pensions, e.g. occupational schemes and private savings. In this section, the possible impact of those additional pensions will be considered. They will be referred to as "private pensions", which excludes here the private part of mandatory schemes whose impact has already been addressed above (see second column of Table IV.2).
-  Case of countries where private pensions have been traditionally low (DE, FR, IT, AT, PT, PL, EE, LV, SK and MT)
The future contribution of occupational and individual private savings to compensate the decrease in the benefit ratio provided by public and private mandatory schemes mainly depends on whether the coverage has recently increased or will increase in the coming years. This distinction is also important for the evolution of public finances. Namely, if the coverage (number of people and/or average contribution rate) has recently increased, the contribution of private pensions to the replacement rate will increase over time whereas the budgetary cost related to those increased savings has already occurred.
On the other hand, if contributions to individual private schemes are still to increase after the medium term, it may imply further budgetary cost in countries where such savings are tax exempt. The recent evolution of the coverage of pension schemes is not available in a sufficient quality, which makes it difficult to draw strong conclusions. However, assets already accumulated are generally small and the current coverage of private occupational/supplementary pensions is limited (except DE and to a lesser degree AT). Therefore, unless the coverage of private schemes and the level of contributions acknowledge a strong increase, it seems unlikely that current saving rates will totally compensate the decrease in the public benefit ratio. The reform of the TFR in Italy, which will redirect on a silent assent basis lump-sum benefits for redundary payment into a private fund, will increase the coverage of private pensions.
-  Case of countries where private pensions have been traditionally higher (SE and UK)
Sweden provides projections for occupational and supplementary schemes in the Ageing Report: when including those additional pensions, the decrease in the benefit ratio is of the same magnitude albeit from a significantly higher level (private pensions outlays are currently around 2 ½ point of GDP). There is no such projection available for the UK in the Ageing Report. However, according to the Turner reports, the " underlying trend in private sector employer pension contributions has been downwards since the early 1980s " and defined benefit schemes have been replaced by less generous defined contribution schemes.[74] Both trends suggest that current contribution rates to private schemes will not compensate the decrease in the benefit ratio.
Table IV.4. Level of assets in occupational/individual pension schemes and coverage
Levels of assets in occupational schemes and individuals schemes as a share of GDP (year) | Percentage of employees contributing to a private pension scheme (individual or occupational) |
BE | 37% (2002) | 40-45% |
CZ | 3.2% (2003) | 40% individual |
DK | 120% (2003) | 95% |
DE | 3.4% (2002) | 60% occupational; 13% 'Riester' legislation |
EE | 0.7% (2004) | 8% individual |
EL | Na | Nearly no coverage |
ES | 12.4% (2003) | 44% |
FR | 3% (2003) | 10% occupational and 8% life insurance |
IE | 43% (2002) | 52% |
IT | 3% (2003) | 8% occupational 2% individual |
CY | 13.1% (2000) | 27% in the private sector 13% in the public sector |
LV | 0.3% (2003) | 3% individual |
LT | 0.2% (2004) | 8% individual |
LU | 4.0% (2004) | 20% occupational and 2% individual |
HU | 2.3% (2003) | 31% voluntary pension plans |
MT | Na | Negligible for occupational schemes and NA for other private schemes |
NL | 131% (2001) | 90% |
AT | 4% (2004) | 35% occupational 10% individual |
PL | 0.1% (2003) | NA (<49%) |
PT | 12% (2002) | 4% occupational and 1.5% individual |
SI | 1.7% (2004) | 51% occupational schemes |
SK | 0.95% (2003) | NA (<27%) |
FI | 11.1% (2003) | 5% occupational and 12% individual |
SE | 62% (2003) | 90% occupational and 40% individual |
UK | 102% (2001) | 50% |
Note: Figures for coverage from different types of schemes do note necessarily add up (there can be double counting).
Source Special Study on Privately managed pensions, SPC (2005):http://ec.europa.eu/comm/employment_social/social_protection/pensions_en.htm
Table IV.5. Age at retirement of new flows of retirees and average exit age from the labour market
Age at retirement of new flows of retirees total (men/women) | Average exit age from the labour market (2001) | Average exit age from the labour market (2004) | Stat. retirement age (M=men, W=Women, PR=private sector, PU=Public sector) |
BE | NA (64/61.6) | 56.8 | 59.4 | PR 65 M 64W PU 65 |
CZ | 58 (60.2/56.3) | 58.9 | 60.0 | 63M 61W with two children |
DK | 62.1 (62/62.3) | 61.6 | 62.1 | 65 |
DE | (63.1/63.2) | 60.6 | 61.3 | 65 |
EE | 60.3 (61.5/59) | 61.1 | 62.3 | 63M 59.5W |
EL | 60.4 (61.4/58.6) | 59.3 | 59.5 |
ES | 62.9 (62.9/63) | 60.3 | 62.2 | 65 |
FR | NA (60.6/62.0) | 58.1 | 58.9 | 60 |
IE | 65 | 63.2 | 62.8 | 65/66 depending on the scheme |
IT | 59.7 (59.8/59.6) | 59.8 | 61.0 | 65M 60W |
CY | 62.7 (Nd/Nd) | 62.3 | 62.7 | 61M 60W |
LV | 60.3 (61.4/58.3) | 62.4 | 62.9 | 62M 60W (62 as if 1.7.2008) |
LT | 60 (61.4/58.4) | 58.9 | 60.8 | 62.5M 60W |
LU | Nd (60.3/62.4) | 56.8 | 57.7 | After 40 years of working lifetime |
HU | 58.5 (59.7/57.3) | 57.6 | 60.5 | 62M 60W |
MT | 60.8 (61.5/60.5) | 57.6 | 57.7 | 61M 60W |
NL | 65 (65/65) | 60.9 | 61.1 | 65 |
AT | 60.4 (62.7/58.9) | 59.2 | 58.8 | 65 (W phased in by 2033) |
PL | 56.8 (58.7/56.0) | 56.6 | 57.7 | 65M 60W |
PT | 64.2 (63.7/64.8) | 61.9 | 62.2 | 60.5 |
SI | 63.2 (63.7/62.7) | 56.2 | 63M 61W |
SK | 58.5 (61.4/56.8) | 57.5 | 58.5 | 62 |
FI | 59.1 (59.0/59.3) | 61.4 | 60.5 | Flexible 63-68 |
SE | 64.7 (64.8/64.7) | 61.8 | 62.8 | Flexible, from 61 onwards |
UK | 62.3 (62.7/61.9) | 62.0 | 62.1 | 65M 60W |
Source: SPC for the first column (' Current and prospective theoretical pension replacement rates', SPC (2006)), Deutsche Rentenversicherung (2006) for DE and refers to the year 2003 except for the UK (2002) and Germany (2005) and EPC for the other three.
Effective age of retirement
Current employment rates of older workers
Table IV.5 and Table IV.6 show that there is a large scope for increasing total employment rates and employment rates of older workers and that the effective exit age from the labour market is often below the official retirement age. The currently low employment rates of people aged 55-64 in some countries (notably IT, AT, MT, PL and SK and to a lesser degree DE, FR and LV) may suggest either low financial incentives to retire later (e.g. generous pre-retirement schemes, generous pay-as-you go, low age to be entitled to a full pension, etc.) or barriers to old-age activity (e.g. age discrimination, differential between wages and productivity of older workers, etc.).
Usually supply-side factors are addressed by the pension reforms.[75] Yet, pension reforms are still recent and transition periods are sometimes long so that the effects on employment rates will be progressive. But the possibility of other barriers limiting old-age activity cannot be ruled out. To ensure that pension reforms will effectively result in a higher effective retirement age rather than low pensions, it is important to remove such barriers.
Table IV.6. Employment rates in the EU in 2003 and in the projections
Employment rate |
15-64 | 55-64 |
2003 | 2050 | Change | 2003 | 2050 | Change |
Note : A plus sign signals a risk-increasing factor while a minus sign signals a risk-decreasing factor. LTC stands for long-term care. The heading ‘Additional projections’ comprise national long-term projections of changes in primary revenues and changes in property income as a share of GDP, see Chapter V-3 for further details.
* It should be noted that for Malta, the significant decrease in pension contributions and in public revenues – and pension expenditure – is a risk-increasing factor.
** For the debt/GDP ratio, the following thresholds are used: a debt level of 0-20% of GDP is 'very low', of 21-40% is 'low', of 41-60% is 'medium', of 61-80% is high and 80% or more is 'very high'.
*** According to the Spring 2006 Commission forecast up to 2007.
Source : Commission services.
Main sustainability challenges that Member States are facing
The budgetary impact of ageing populations is a concern for all EU Member States. There is however a large variation in the degree of risks that they are facing and where they mainly come from. This section summarises the different risks that the EU Member States are facing with regard to the long-term sustainability of the public finances. The results are very similar in the Council/Commission assessment of the 2005/06 stability/convergence programmes.[101] Overall, six countries are assessed to be at high risk , ten at medium risk and nine at low risk . The assessments made by the Council of the 2005/06 SCPs are provided in Annex 3.
-  high-risk countries
All high-risk countries exhibit a strong increase in age-related expenditures up to 2050 (for Greece the 2002 stability programme projected an increase of pension expenditure of around 10p.p. of GDP).[102]
As regards the current budgetary position, only Slovenia has relatively sound public finances with a level of debt slightly under 30% of GDP and a relatively limited structural public deficit (-1.5% of GDP in 2005). However, it should be noted that Slovenia has not yet reached its MTO, set at -1% of GDP.
The Czech Republic has a level of debt under 40% of GDP and the structural balance in 2005 was -1.4% of GDP. However, this was due to the favourable economic situation and deferred spending, rather than structural expenditure cuts. The 2006 Commission Spring forecast projects a worsening of the structural budget balance to -4.0 p.p. of GDP in 2007.
Hungary's debt/GDP ratio is close to the Treaty threshold but its current structural deficit is very large, which implies large sustainability risks for the Hungarian public finances, even without taking account of the impact of ageing on public finances and is even projected to deteriorate further under current policies at -6.9 p.p. of GDP in 2007 in the 2006 Commission Spring forecast.
Finally, Greece, Cyprus and Portugal have a debt above 60% of GDP and the structural deficit is close (CY) or above 3% of GDP (EL and PT) in 2005.
The high risk group of countries (CZ, EL, CY, HU, PT and SI) is characterised by a very significant rise in age-related expenditure over the long-term, underlining that measures aimed at curbing them will prove necessary. Moreover, CZ, EL, CY, PT and HU have large deficits and in some cases also a high level of debt, in particular in Greece. Budgetary consolidation is therefore necessary and urgent in order to reduce risks to public finance sustainability.
-  medium-risk countries
The intermediate category consists of countries with very different characteristics but they can still be classified in four different groups depending on the budgetary costs of ageing population:
-  In Slovakia, Italy, France, Germany, the United Kingdom, the increase in age-related expenditure over the long-term is close to or below the EU average due to pension reforms (SK, IT, DE and FR) or to the traditionally lower level of public pensions (SK and UK). While not identical, the current budgetary position can be qualified as weak or very weak. Two countries have a medium level of debt (UK and SK); however, the current structural deficit is large in the UK (-3.3%) and in Slovakia while the current structural deficit is smaller (-1.6%), it would be larger by 0.6 p.p. of GDP when taking into account the diverted revenue to the private part of the mandatory pension schemes (which will take effect from 2007 onwards). France and Germany have a level of debt above the 60% of GDP reference value and they have structural deficits close to the Treaty threshold. Finally, Italy has still a large very high level of debt, above 100% of GDP and a current structural deficit close to 4%. For these countries, medium-term consolidation of the public finances is key to ensure the long-term sustainability of public finances, notably for countries with a high current level of debt.
-  In Belgium, Ireland and Spain the increase in age-related expenditure is significantly higher than on average in the EU, due to relatively high expenditure on pensions being projected. The current budgetary position contributes to alleviate part of this increase; with the level of debt being well below the 60% of GDP threshold in IE and ES. In BE, the current level of the debt is very high but the high primary surplus, subject to being maintained for a long period of time can compensate for a significant part of the budgetary costs of ageing. Nonetheless, measures to curb the future costs of ageing may be necessary so as to put the public finances on a more sustainable path in BE, IE and ES, unless the current budgetary position is strengthened further, which would imply higher primary surpluses than at present.
-  In Luxembourg, a significant increase in pension expenditure is projected over the long-term. Though the level of debt is very low and large assets have been accumulated in public pension funds, it will not be sufficient to compensate for the large projected increase in pension expenditure and some changes in the pension schemes will prove necessary at some point.
-  Although public expenditures are projected to show little change over the long-term, the pension system in Malta is currently being reviewed and reforms are envisaged, with a view to improve its financial sustainability and adequacy over the long term. Moreover, the currently high structural deficit, if not corrected, will prevent the necessary reduction of the debt/GDP ratio, currently above the 60% reference value.
The intermediate group of countries (BE, DE, ES, FR, IE, IT, LU, MT, SK and UK) consists of countries with very different characteristics but a relatively clear-cut distinction appears between: (i) countries with a significant cost of ageing and where measures might be needed to curb these costs, but which currently have relatively strong budgetary positions (ES, IE and LU); and, (ii) countries that need to consolidate, though to different degrees, their public finances over the medium-term but for which the costs of ageing are less of a concern, usually as a result of enacted reforms to their pension systems (SK, IT, DE, FR, UK and MT); in Italy rapid budgetary consolidation is required to ensure a steady reduction of the currently very high level of debt. Belgium share some characteristics of both sub-groups; maintaining a strong budget balance is necessary so as to reduce the very high level of debt as well as to offset the high increase in age-related expenditure, being above the EU average. However, even if it is maintained for a long period of time, the current high primary surplus is not sufficient to fully cover the relatively high cost of ageing populations over the long-term. Measures aiming at curbing the projected increases in pension expenditure would undoubtedly contribute to reduce the risks to sustainability.
-  low-risk countries
Finally, the low risk countries can be divided in three different groups:
-  In Poland, pension expenditure are projected to decrease significantly by 6 p.p. of GDP between 2004 and 2050, thus showing no adverse budgetary impact of ageing. At the same time, the current deficit is -2.5% of GDP and the debt amounts to 42.5% of GDP. However, when corrected for the diverted revenue to the private mandatory scheme and the Maastricht debt deductible assets in this private pension fund, with effect as of 2007, the general government deficit and debt would be higher by respectively 1.9 p.p. of GDP and 5.4 p.p. of GDP.
-  In Austria, Sweden, Estonia, Lithuania and Latvia, the pension reforms have strongly contained the increase in pensions over the next 50 years. Except for Austria where the debt level is still slightly above the Treaty threshold, the level of debt is rather low (in SE) and sometimes very low (in EE, LT and LV). Moreover, the structural deficit is close to balance (in LT and LV) or in surplus (EE and SE).
-  In Denmark, Finland and the Netherlands, the rise in age-related expenditure is higher than on average in the EU. Yet those countries currently have a low (DK) or medium (NL, FI) level of debt and are currently experiencing structural surpluses, sometimes very high (DK and FI), which strongly contribute to cover a large part of the future cost of ageing. However, over the medium-term, those countries may be faced with the policy choice between maintaining large surpluses or implementing pension reforms (DK and NL) or additional pension reforms (FI).
The low risk countries (DK, EE, LV, LT, NL, AT, PL, FI and SE) have in general come furthest in coping with ageing, which implies either a strong budgetary position (running large surpluses, reducing debt and/or accumulating assets) and/or comprehensive pension reforms, sometimes including a shift towards private pension schemes. This does not mean that in these countries there are no risks regarding the long-term sustainability of public finances. In fact, their situation (assessment) relies on the successful implementation of the far-reaching reforms, which have reduced significantly the long-term budgetary impact of ageing (EE, LV, LT, AT, PL and SE) and maintaining the budgetary position, and in some cases strengthening it. Other countries with a relatively high projected cost of ageing, notably on pensions, may also need to consider structural reforms aimed at modifying the projected long-term budgetary trends at some point, unless the strong budgetary position is maintained (DK, NL and FI), although to a lesser degree than medium and high risk countries.


Chapter VI
Country analysis
Legend to the country tables
SP | Stability Programme |
CP | Convergence Programme |
MTO | Medium-Term Objective for the government's budgetary position |
NAIRU | Non-Accelerating Inflation Rate of Unemployment |
S1 | Sustainability indicator that measures the size of a permanent budgetary adjustment than enables reaching a debt ratio of 60% of GDP in 2050 |
S2 | Sustainability indicator that measures the size of a permanent budgetary adjustment than fulfils the government's intertemporal budget constraint over an infinite horizon |
IBP | Initial Budgetary Position, the distance between the current primary balance and the primary balance that stabilizes debt as a share of GDP over the long-term, see Chapter I. |
LTC | Long-Term Change in the budgetary position, the increase in age-related expenditure over the long-term, see Chapter I. |
DR | Debt Requirement in 2050; the impact of the distance between the initial level of debt as a share of GDP and a level of 60% of GDP in 2050 (specific to the S1 indicator), see Chapter I. |
RPB | Required Primary Balance; the S2 sustainability indicator plus the structural primary balance over the first five years of the projections period, see Chapter I. |
Baseline scenario | Scenario in which the sustainability indicators are calculated using the structural primary balance in 2005 at the outset and the projected change in age-related expenditure in the period from 2010 to 2050, see Chapter II. |
MTO scenario | Scenario in which it is assumed that all Member States attain their MTOs in 2010, see Chapter III. |
Cost of delay | the 'cost of a delay' indicator shows the increase in the sustainability indicators that would result from a delay of five years in implementing budgetary consolidation compared to the baseline, see Chapter III. |
Sensitivity to changes in assumptions | It shows the impact on the S2 sustainability indicator of changes in demographic and macroeconomic assumptions, see Chapter III |
Scenarios for health-care | It shows the impact on the S2 sustainability indicator of alternative health-care assumptions, see Chapter III |
Scenarios for long-term care | It shows the impact on the sustainability indicator of alternative long-term care assumptions, see Chapter III. |
Belgium
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Belgian economy is projected to experience a slowdown of economic growth over the coming decades, from 2.4% during 2004-2010 to 1.8% in 2011-2030 and a further decline to 1.5% in 2031-2050, influenced by an ageing population.[103] The old-age dependency ratio is projected to rise from 26% in 2004 to 47% in 2050, albeit a smaller rise than on average in the EU.
The projected increase in age-related spending in Belgium of 6.3% points of GDP between 2004 and 2050 is significantly above the EU average. Most of the projected increase during this period is due to the rise in pension expenditures, amounting to 5.1% points of GDP. The increase in public spending on health-care and long-term care is close to the EU average.
The Belgian public finances have been sound in the recent past with the government finances in balance or in surplus since 2001, and a surplus of 0.1% of GDP in 2005.[104] This has enabled a reduction of the debt/GDP ratio, which has fallen from over 130% of GDP in 1993 to 93.3% in 2005, thus still above the 60% of GDP Treaty reference value. The budgetary strategy outlined in the stability programme aims at gradually building up surpluses up to 0.7% of GDP by 2009, in order to maintain the debt ratio on a downward trend. The programme projects the debt ratio to decline by 16% points of GDP over the programme period, to less than 80% of GDP in 2009. The MTO set in the stability programme at +0.5% of GDP in structural terms is according to the programme expected to be achieved in 2007. According to the Commission services 2006 spring forecast, a deficit of 0.9% of GDP is expected in 2007 on the basis of the current policies, below the programme's forecast of a surplus of 0.3% (0.4% in structural terms), suggesting that budgetary outcomes could be worse than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Belgium has a sustainability gap of 1.8% of GDP in the baseline scenario. The long-term budgetary impact of ageing is above the EU average, reflecting an important increase in pension expenditure as a share of GDP.
The initial budgetary position, with a currently still high although declining structural primary balance of 4.5% of GDP in 2005 (compared to 6.1% in 2001), contributes to a rapid reduction of debt, which will on the basis of the current policies continue over the medium term.[105] Therefore, assuming that the MTO of a structural balance of 0.5% of GDP is reached in 2010, the structural primary balance becomes smaller; falling from 4.5% in 2005 to 3.7% of GDP in 2010 since interest expenditure on debt fall over the medium term. The lower structural primary balance in 2010 would have a negative impact on the sustainability gap, rising to 2.4% of GDP in the MTO scenario, since the impact of a lower primary surplus is larger than the impact of a lower level of debt. This shows that maintaining a high structural primary surplus over the medium term is key to reduce risks to the long-term sustainability of public finances.
The current level of debt is very high, although it has been resolutely reduced for a number of years. Indeed, debt reduction is the backbone of the Belgian strategy to face ageing. The Belgian authorities have opted to channel most of the future surpluses to an ‘ageing fund’, created in 2001. Investing in the fund amounts to a direct reduction of gross debt but this set-up has the advantage that it reinforces the political commitment of the Belgian government to maintain the necessary primary surpluses to prepare for the cost of ageing. Ensuring a reduction of debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce public finance sustainability risks.
The tax burden on labour in Belgium is among the highest in the EU and the government's current strategy is to reduce it. These measures, aiming at increasing employment rates and fostering growth, could therefore ease pressure on public finances in the long term, though it may reduce revenues in the short term.
It should be noted that the Belgian authorities project a slight reduction of family allowances (of around ½% points of GDP) up to 2050. At the same time, a higher increase in health-care expenditures compared with the reference scenario is projected up to 2050 by the Belgian authorities, about ¾% points of GDP higher. The overall impact is however small.
Overall assessment
The long-term budgetary impact of ageing in Belgium is above the EU average, influenced notably by a large increase in pension expenditure as a share of GDP over the coming decades.
The initial budgetary position with a high primary surplus contributes to easing the projected long-term budgetary impact of an ageing population, but it is not sufficient to fully cover the substantial increase in expenditure. Moreover, the current level of gross debt, while declining, remains well above the Treaty reference value. The steady reduction of the debt/GDP ratio requires sustaining high primary surpluses for a long period of time, which would be key in view of reducing risks to the sustainability of public finances.
Overall, Belgium appears to be at medium risk with regard to the sustainability of public finances.


[pic] 
 The Czech Republic
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the economy of the Czech Republic is projected to experience a slowdown of economic growth over the coming decades, from 3.5% during 2004-2010 to 2.6% in 2011-2030 and a further decline to 0.8% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[106] The old-age dependency ratio is projected to more than double from 20% in 2004 to 55% in 2050, a significantly higher rise than on average in the EU.
The projected increase in age-related spending in the Czech Republic of 7.2% points of GDP between 2004 and 2050 is significantly above the EU average. Most of the expected increase during this period is due to the rise in pension expenditures of 5.6% points of GDP. The increase in expenditure on health-care is projected to be 2% points of GDP, slightly above the EU average, while on long-term care an increase of 0.4% points of GDP is projected, slightly below the EU average.
In 2005, the deficit of the Czech Republic was below the 3% of GDP reference value for a second consecutive year. The fiscal outturn of -2.6% of GDP was considerably better than expected in the last update of the convergence programme (-4.8% of GDP). This was due to the favourable economic situation and deferred spending, rather than structural expenditure cuts. Low deficits in latest years facilitated a stabilisation of the debt/GDP ratio. The budgetary strategy outlined in the convergence programme aims at reducing the deficit to 2.7% in 2008, in line with the Council recommendation under Article 104(7). The adjustment towards the MTO set in the convergence programme at around -1% of GDP is expected to be achieved beyond the programme period, in 2012. According to the Commission services 2006 spring forecast a deficit of 3.4% of GDP is expected in 2007 on current policies, close to the programme's forecast of 3.3%, despite the better-than-expected outturn in 2005.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, the Czech Republic has a sustainability gap of 5.5% of GDP in the baseline scenario. The long-term budgetary impact of ageing is above the EU average, reflecting an important increase in pension expenditure as a share of GDP.
The initial budgetary position, with a structural primary balance of -0.2% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing, pointing to the importance of strengthening the budgetary position. Indeed, assuming that the MTO of a structural balance of -1% of GDP is reached in 2010, the structural primary balance improves; rising from -0.2% in 2005 to 0.2% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap; however, the gap would still be 5.1% of GDP in the MTO scenario.
It should be noted that the authorities in the Czech Republic project a higher increase in health-care expenditures over the long-term compared with the reference scenario, of about 1% of GDP, suggesting that the budgetary cost of ageing could be higher.
Overall assessment
The long-term budgetary impact of ageing in the Czech Republic is higher than the EU average; influenced notably by an important increase in pension expenditure as a share of GDP.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Consolidating the public finances further than currently planned together with the implementation of structural reforms aimed at containing the significant increase in age-related expenditures would be key in view of reducing risks to the sustainability of public finances.
Overall, the Czech Republic appears to be at high risk with regard to the sustainability of public finances.



 [pic] 
 Denmark
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Danish economy is projected to experience some slowdown of economic growth over the coming decades, from 2.0% during 2004-2010 to 1.6% in 2011-2030 and in 2031-2050, influenced by an ageing population.[107] The old-age dependency ratio is projected to rise from 22% in 2004 to 42% in 2050, albeit a smaller increase than on average in the EU.
The projected increase in age-related spending is above the average of the EU; rising by 4.8% points of GDP between 2004 and 2050. Most of the projected increase during this period is due to the higher pension expenditures of 3.3% points of GDP. The increase in expenditure on health-care is projected to be 1% point of GDP, below the average in the EU, while on long-term care a rise of 1.1% points of GDP is projected, slightly above the average in the EU.
In the calculations, the Danish government finances are reduced by the revenue-reducing impact of Eurostat's decision on the classification of funded defined contribution pension schemes that will take effect from 2007 onwards. The MTO is also technically adjusted downwards, by 1% of GDP in the MTO scenario (see Chapter III for further information). The figures with this adjustment are given in brackets in this part.
The Danish public finances have been sound in the recent past; with the government finances in surplus since the latter half of the 1990s and in 2005 an exceptionally high surplus of 4.9% (4%) of GDP was noted, considerably better than 3.6% (2.7%) of GDP expected in the 2005 convergence programme. As a result of the strong fiscal position in recent years, the debt/GDP ratio has been reduced by more than 10% of GDP in four years to reach 35.8% (36.2%) of GDP in 2005. The Danish 2005 convergence projects a return towards the fiscal target range over the medium-term and aims for a surplus of 2.9% (1.9%) of GDP in 2010. The MTO set in the convergence programme at 1½% to 2½% (½% to 1½%) of GDP is already attained with the better than expected fiscal outturn in 2005 (according to the Danish authorities, temporarily high tax revenues in 2005 contribute to the very large surplus by around 2% of GDP).[108] The Commission services' 2006 spring forecast expects a surplus of 4% (3%) of GDP in 2007 on the basis of current policies, above the programme's forecast of 3.2% (2.2%), suggesting that budgetary outcomes could be better than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Denmark does not have a sustainability gap (S2 is -2.2% of GDP) in the baseline scenario. The long-term budgetary impact of ageing is higher than the average in the EU, reflecting notably a relatively high increase in pension expenditure as a share of GDP over the long-term.
The initial budgetary position with a currently very high structural primary balance of 7.1% (6.2%) of GDP in 2005 contributes to a rapid reduction of debt, which will on current policies continue over the medium-term. Assuming that the MTO of a structural balance of 1% of GDP is reached in 2010, the structural primary balance becomes smaller; falling from 6.2% in 2005 to 1.8% of GDP in 2010, influenced in part by interest expenditure on debt falling over the medium-term. The lower structural primary balance in 2010 would have a negative impact on the sustainability gap, rising to 2.4% of GDP in the MTO scenario. It should be noted that the Danish 2005 convergence programme projects a surplus of 2.9% (1.9%) of GDP in 2010, above the MTO of 1½% to 2½% (½% to 1½%). Under the assumption that this surplus in 2010 would materialise, the sustainability gap would be reduced by some 1% of GDP as compared to the MTO scenario.
According to Danish long-term projections, revenues are projected to increase over the long-term by 1% of GDP between 2010 and 2050, mainly due to deferred taxation of private pensions (+3% of GDP). This impact is important in Denmark, as private pension schemes currently hold large assets and are expected to accumulate them further since contributions to these schemes should still be higher than the corresponding pension outlays for a long period of time.
However, general government property income in Denmark, consisting of both revenues from financial assets and from natural resources, amounted to 2.2% of GDP in 2005 which is higher than on average in the EU. As shown in Chapter IV, revenues from property income might be lower by about half of this amount over the long-term, suggesting that risks to public finance sustainability might be underestimated. General government property income revenues could in fact be even lower in the future under the assumption that natural resources would be depleted and that those revenues would vanish over the long-term, which is also projected in the Danish convergence programme. These revenue projections suggest that the long-term budgetary position could be better by around 1% point of GDP. Overall, these national projections do not significantly alter the outlook for the long-term sustainability of the Danish public finances.
Denmark has among the highest levels of taxation in the EU, suggesting that there is limited room of manoeuvre to meet expenditure increases by adjusting the budget on the revenue side.
Pension policy is currently under review in Denmark, and the government has proposed a welfare reform package.[109] Some of these main elements of the welfare reform package are: (i) gradual increase of the retirement age by in total 2 years; (ii) indexation of the age thresholds to increased longevity; (ii) increased contribution to the early retirement system; (iv) earlier start of tertiary education; (v) faster study completion; (vi) earlier activation of unemployed. The total net effect on public finances of the reform package is foreseen by the Danish authorities to equal about 1.5% of GDP; the gross impact of the package of 2% of GDP consists of 1.5% from later retirement and indexation of the retirement age and 0.5% from the other measures. Of these resources, 0.5% of GDP will be used to finance a Globalisation Fund that will invest in research and development.
Overall assessment
The long-term budgetary impact of ageing in Denmark is higher than on average in the EU; influenced notably by a relatively high increase in pension expenditure as a share of GDP over the coming decades.
The initial budgetary position with a currently very high primary surplus in 2005 (which is influenced by temporary factors) would, if maintained, contribute significantly to ease the long-term budgetary impact of ageing. The projected future rise of revenues as a share of GDP, mainly due to deferred taxation of pensions, would further alleviate the increase in public expenditure over the long-term. Maintaining high primary surpluses over the medium-term would be key in view of containing risks to the sustainability of public finances.
Overall, Denmark appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Germany
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the German economy is projected to experience a slowdown of economic growth over the coming decades, from 1.7% during 2004-2010 to 1.4% in 2011-2030 and a further decline to 1.2% in 2031-2050, influenced by an ageing population.[110] The old-age dependency ratio is projected to rise from 27% in 2004 to 52% in 2050, close to the average increase in the EU.
The projected increase in age-related spending in Germany is slightly below the average of the EU; rising by 2.7% points of GDP between 2004 and 2050. The increase in expenditure on pensions is projected to be relatively limited in Germany, rising by 1.7% points of GDP due to large reforms enacted in the past since the beginning of the 90s, the latter (2004) with the introduction of a 'sustainability factor' which reflects changes in the ratio between pension contributors and pension recipients. The sustainability factor contributes to make the pension system robust to changes in assumed life expectancy, as pensions are automatically adjusted. The increase in health-care expenditure is projected to be 1.2% points of GDP, lower than on average in the EU.
The projected increase in expenditure on long-term care in the reference scenario does however not reflect current legislation in Germany, where long-term care benefits (i.e. benefits paid out by the public insurance for people receiving formal care at home, care in institutions or cash benefits) are fixed by law without any indexation. A scenario with long-term care expenditure remaining constant as a share of GDP would come closer to the current setting of legislation, which would in turn imply a lower increase in age-related expenditure, of 1% point of GDP (and would reduce the S2 sustainability indicator by 0.7% of GDP).[111] However, if unit costs of supplying long-term care increase more than general price level of the economy – as it is assumed in the Ageing Report, this could lead to an increasing gap between needs and provisions of public long-term care.
Germany has been placed in excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2007 at the latest. The deficit was 3.3% in 2005, after having been above 3% of GDP since 2002. As a result of the weak fiscal position in recent years, the debt/GDP ratio has risen by almost 10 p.p. of GDP in four years, to reach 67.7% of GDP in 2005, above the Treaty reference value. The German stability programme of February 2006 projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1½% of GDP in 2009. The adjustment towards the MTO set in the stability programme at balance in structural terms is expected to be achieved beyond the programme period. According to the Commission services 2006 spring forecast a deficit of 2.5% of GDP is expected in 2007 on the basis of current policies, coinciding with the programme's forecast of 2½% of GDP, suggesting that budgetary plans seem to be attainable.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Germany has a sustainability gap of 4.4% of GDP in the baseline scenario. The long-term budgetary impact of ageing is below the average in the EU, reflecting a relatively limited increase in pension expenditure as a share of GDP, influenced by the pension reforms enacted.
The initial budgetary position, with a structural primary balance of -0.3% of GDP in 2005, is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance improves; rising from -0.3% in 2005 to 2.8% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap, which is reduced to 1.2% of GDP in the MTO scenario. This shows the importance of strengthening the structural primary surplus over the medium-term so as to reduce sustainability risks.
The current level of debt is higher than 60% of GDP in Germany and it has been increasing in recent years. Ensuring a reduction of debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce public finance sustainability risks.
The benefit ratio in Germany is projected to decrease relatively markedly, by around 20% in the period to 2050. Employment rates of older workers in Germany (39%) are currently close to the EU average (40%) but are projected to increase more than on average in the EU. A further increase in the employment rate of older workers than assumed in the projections would contribute to reduce the projected relatively marked decrease in the benefit ratio. Indeed, a large increase in employment rates of older workers would foster GDP growth and ensure that workers can accumulate more pension rights. However, the increase in recent years of private pension contributions (occupational and individual) in Germany may contribute to partly compensate for the projected decrease in the public benefit ratio and notably so if this trend continues.
The German 2006 stability programme provides a projection of pension contributions ( Beitragseinnahmen ), which rises by 1.6% of GDP between 2010 and 2050. This projection fills part of the gap that emerges between pension expenditure and contributions, taking also into account the above-mentioned sustainability factor. Nevertheless, a sustainability gap would remain.
Overall assessment
The long-term budgetary impact of ageing in Germany is close to the EU average; with pension expenditure showing a somewhat more limited increase than in many other countries, influenced by the pension reforms enacted. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. Increasing the employment rates of older workers would improve workers' pensions in the future and ensure the success of the pension reforms.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of ageing populations. Moreover, the current level of gross debt is above the Treaty reference value. Consolidating the public finances would therefore be key in view of reducing risks to the sustainability of public finances.
Overall, Germany appears to be at medium risk with regard to the sustainability of public finances.
[pic] 
 Estonia 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Estonian economy is projected to experience a slowdown of economic growth over the coming decades, from 6.1% during 2004-2010 to 3% in 2011-2030 and a further decline to 1.2% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[112] The old-age dependency ratio is projected to rise from 24% in 2004 to 43% in 2050, albeit a smaller increase than on average in the EU.
Age-related spending is projected to fall by 2.4% points of GDP in Estonia between 2004 and 2050, the second largest decrease in the EU. This is mainly due to a projected fall in public expenditure on pensions by 2.5% points of GDP, as a result of a comprehensive pension reform. The pension system consists of a PAYG scheme and a compulsory funded defined contribution scheme, the latter enacted in 2002. The increase in expenditure on health-care is projected to be 1.1% points of GDP, below the EU average and close to that of the EU10. An increase of 0.3% points of GDP is projected for expenditure on long-term care, a lower rise than on average in the EU.
The Estonian public finances have been sound in the recent past; with the government finances in surplus since 2001. In 2005, a surplus of 1.6% of GDP was recorded, considerably better than 0.3% of GDP expected in the 2005 convergence programme. As a result of the strong fiscal position in recent years, the debt/GDP ratio has been kept at very low levels, reaching 4.8% of GDP in 2005. The Estonian 2005 convergence programme targets a balanced budget from 2007 through 2009, coinciding with the MTO set to balance in structural terms. The MTO is thus already more than attained. According to the Commission services 2006 spring forecast, a surplus of 0.8% of GDP is expected in 2007 on the basis of the current policies, above the programme's forecast of a balanced budget, suggesting that the budgetary outcomes could be better than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Estonia does not have a sustainability gap in the baseline scenario (S2 is -3.4% of GDP). The long-term budgetary impact of ageing is among the lowest in the EU reflecting a projected reduction in pension expenditure as a share of GDP over the long-term, influenced by the pension reforms enacted.
The initial budgetary position with a structural primary surplus of 1.7% of GDP in 2005 enables to maintain debt at a very low level. Assuming that the MTO of a structural balance is reached in 2010, the structural primary surplus becomes smaller; falling from 1.7% of GDP in 2005 to balance in 2010. The lower structural primary balance in 2010 would have a negative impact on the sustainability indicator; however, a sustainability gap does not emerge in the MTO scenario either (S2 is -1.7% of GDP).
Under current policies, the benefit ratio in Estonia is projected to decrease quite markedly, by more than 25% in the period to 2050, despite a relatively low level of public pension expenditure today.[113] Pressure on current pension arrangements cannot be excluded in the long term.
Overall assessment
The long-term budgetary impact of ageing in Estonia is among the lowest in the EU; influenced notably by the projected reduction in pension expenditure as a share of GDP over the coming decades. However, current pension arrangements may come under pressure at some point if the decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded.
The current level of gross debt is very low in Estonia and maintaining sound government finances, of a balanced budget, would contribute to contain the risks to the long-term sustainability of public finances.
Overall, Estonia appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Greece
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Greek economy is projected to experience a slowdown of economic growth over the coming decades, from 2.9% during 2004-2010 to 1.6% in 2011-2030 and a further decline to 0.8% in 2031-2050, influenced by an ageing population.[114] The old-age dependency ratio is projected to increase from 26% in 2004 to 60% in 2050, a higher rise than on average in the EU.
The projected increase in age-related spending in Greece is not comparable with the other Member States, since projections for pension expenditure are not available in the Ageing Report. The latest available projections included in the 2002 Greek stability programme showed a very considerable increase of 10.2% points of GDP from 2005 up to 2050. The increase in expenditure on health-care is projected to be 1.6% points of GDP from 2005 up to 2050, close to the EU average. No projections of long-term care expenditure are available.
Greece has been placed in the excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2006 at the latest. The deficit was 4.5% in 2005, after having been above 3% for many years. As a result of the weak fiscal position in recent years, the debt/GDP ratio has remained very high and was 107.5% of GDP in 2005, well above the Treaty reference value.[115] The Greek 2005 stability programme projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.7% of GDP in 2008. The adjustment towards the MTO set in the stability programme at balance in structural terms is expected to be achieved beyond the programme period. According to the Commission services 2006 spring forecast a deficit of 3.6% of GDP is expected in 2007 based on a no-policy-change scenario, well above the programme's forecast of 2.3% of GDP, suggesting that budgetary outcomes could be significantly worse than expected.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, even without including projected expenditure on pensions which in all likelihood significantly underestimates the sustainability gap, Greece has a gap of 3% of GDP in the baseline scenario. This is due to the weak initial budgetary position with a structural primary balance of -0.3% of GDP in 2005, which is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance improves; rising from -0.3% in 2005 to 4.3% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap. However, given that the latest available pension projections point to an increase of the more than 10% points of GDP up to 2050, a significant sustainability gap is likely to remain.
The current level of debt is very high in Greece, at 107.5% of GDP in 2005. Ensuring a reduction of the very high debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce risks to public finance sustainability.
Overall assessment
The long-term budgetary impact of ageing in Greece is uncertain as common long-term projections of pension expenditure are not available; however, it is likely to be well above the EU average; according to the latest available information from the 2002 updated Greek stability programme, a significant increase in pension expenditure as a share of GDP is projected over the long-term.
The initial budgetary position is weak and not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Moreover, the current level of gross debt is well above the Treaty reference value and reducing it requires achieving high primary surpluses for a long period of time. Consolidating the public finances as currently planned together with reform measures aimed at containing the likely significant increase in age-related expenditures would be key in view of reducing risks to the sustainability of public finances.
Overall, Greece appears to be at high risk with regard to the sustainability of public finances. 

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Spain
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Spanish economy is projected to experience a slowdown of economic growth over the coming decades, from 3% during 2004-2010 to 2% in 2011-2030 and a further decline to 0.6% in 2031-2050, influenced by ageing populations; the old-age dependency ratio is projected to rise from 25% in 2004 to 66% in 2050, the highest increase in the EU.[116]
The projected increase in age-related spending in Spain is considerably higher than on average in the EU; rising by 8.5% points of GDP between 2004 and 2050. The projected increase in expenditure on pensions is relatively high in Spain, at 7.1% points of GDP. Health-care expenditure is also projected to increase by 2.2% points of GDP more than on average in the EU, while on long-term care an increase of 0.2% points of GDP is projected, less than the average in the EU.
The Spanish public finances have been relatively sound in the recent past; in 2005 a surplus of 1.1% of GDP was recorded, following a close to balance position in the previous two years. As a result, the debt/GDP ratio has been reduced by more than 10% of GDP in four years, standing at 43.2% in 2005. The Spanish 2005 stability programme projects continued surpluses over the medium-term, aiming at 0.6% of GDP in 2008, implying a reduction of the surplus compared with 2005. The programme projects a continued rapid reduction of the debt ratio by 8 percentage points of GDP over the programme period, to less than 36% of GDP in 2008. The structural balance projected in the programme satisfies the MTO set in the convergence programme at balance in structural terms of GDP throughout the programme period to 2008. According to the Commission services 2006 spring forecast a surplus of 0.4% of GDP is expected in 2007 on the basis of the current policies, slightly below the programme's forecast of 0.7%, suggesting that budgetary outcomes could be close to the projections in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Spain has a sustainability gap of 3.2% of GDP in the baseline scenario. The long-term budgetary impact of ageing is significantly above the average in the EU reflecting notably a relatively high increase in pension expenditure as a share of GDP over the long-term.
The initial budgetary position, with a currently high structural primary balance of 3.1% of GDP in 2005, contributes to a rapid reduction of debt, which will on current policies continue over the medium-term. Therefore, assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance becomes smaller; falling from 3.1% in 2005 to 1.2% of GDP in 2010 since interest expenditure on debt falls over the medium-term. The lower structural primary balance in 2010 of almost 2% of GDP would have a negative impact on the sustainability gap, rising to 5.2% of GDP in the MTO scenario. It should be noted that the stability programme projects a surplus in the government finances of 0.6% of GDP, being 0.9% in structural terms in 2008. Assuming that the MTO is achieved in 2010 therefore implies a loosening of the fiscal stance by almost 1% of GDP between 2008 and 2010. In addition, the impact of a lower primary surplus is larger than the impact of a lower level of debt. This shows that maintaining a high structural primary surplus over the medium-term is key so as to reduce risks to the long-term sustainability of public finances.
Pension policy is currently under review in Spain, and the government has proposed a reform package in May 2006.[117] The main points of the proposed reform are: (i) increasing the contribution period; (ii) raising the partial retirement age; (iii) discouraging early retirement; (iv) strengthening incentives to extending the working life; (v) extending widow's pension to fact couples; (vi) adapting the list of occupational illnesses to prevent misuse.
Overall assessment
The long-term budgetary impact of ageing in Spain is significantly higher than the EU average, influenced notably by a considerable increase in pension expenditure as a share of GDP over the coming decades.
The initial budgetary position with a high primary surplus contribute to ease the projected long-term budgetary impact of ageing populations, but it is not sufficient to cover the substantial increase in expenditure due to ageing populations. Therefore, implementing measures within the announced social welfare reform aimed at containing the significant budgetary impact of ageing, notably concerning pensions would be key in view of reducing risks to the sustainability of public finances.
Overall, Spain appears to be at medium risk with regard to the sustainability of public finances. 

[pic] 
 France 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the French economy is projected to experience a slowdown of economic growth over the coming decades, from 2.2% during 2004-2010 to 1.8% in 2011-2030 and a further decline to 1.6% in 2031-2050, influenced by an ageing population.[118] The old-age dependency ratio is projected to rise from 25% in 2004 to 46% in 2050, albeit a smaller rise than on average in the EU.
The projected increase in age-related spending in France is slightly below the EU average; rising by 3.1% points of GDP between 2004 and 2050. The increase in expenditure on pensions is projected to be relatively limited in France, rising by 2% points of GDP due to large reforms enacted in the past, in 1993 for private sector employees and in 2003 for public sector employees and to a lesser degree for private sector employees. Despite the positive effects of the 2004 health reform, the increase in expenditure on health-care is still projected to be 2% points of GDP, slightly higher than the EU average, influenced by relatively high expenditure on health-care at present compared to the average in the EU. An increase of 0.2% points of GDP is projected for expenditure on long-term care, a lower rise than on average in the EU.
France has been placed in excessive deficit procedure and was required to bring the deficit below 3% of GDP by 2005. After having been above 3% since 2002, the deficit was reduced to 2.9% of GDP in 2005 despite the economic slowdown, but the reduction mainly stemmed from one-off measures (notably in connection with the exceptional payments linked to the inclusion of the specific electricity and gas companies’ pension schemes in the general regime which amounted to 0.5% of GDP). As a result of the weak fiscal position in recent years, the debt/GDP ratio has risen by around 10 p.p. of GDP in four years to reach 66.8% of GDP in 2005, above the Treaty reference value. The French 2005 stability programme projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1% of GDP in 2009. The adjustment towards the MTO set in the stability programme at balance in structural terms is expected in the programme to be achieved beyond the programme period, by 2010. The programme deficit targets, at 2.9% of GDP in 2006 and 2.6% in 2007, were updated at the time of the budget preparatory debate that took place in June 2006 to 2.8% of GDP in 2006 and 2.5% in 2007. According to the Commission services 2006 spring forecast, on the basis of the current policies, deficits of 3.0% of GDP in 2006 and 3.1% in 2007 are expected, suggesting that budgetary outcomes could be worse than targeted.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, France has a sustainability gap of 4.0% of GDP in the baseline scenario. The long-term budgetary impact of ageing is slightly lower than the average in the EU, influenced by pension reforms enacted.
The initial budgetary position with a structural primary balance of -0.5% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Indeed, assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance improves; rising from -0.5% in 2005 to 2.5% of GDP in 2010. The higher structural primary balance in 2010 would have a considerable positive impact on the sustainability gap; reducing it to 0.9% of GDP in the MTO scenario. This shows the importance of strengthening the structural primary surplus over the medium-term to reduce sustainability risks.
The current level of debt is higher than 60% of GDP and it has been increasing in recent years. Ensuring a reduction of debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce risks to public finance sustainability. The authorities committed, in their budget preparatory debate documents, to reduce the debt-to-GDP ratio by 2 percentage point in 2006 after the worse than expected outcome in 2005.
The benefit ratio in France is projected to decrease relatively markedly, by around 20% in the period to 2050. Employment rates of older workers are currently lower in France (36%) than on average in the EU (43%) and, while assumed to rise, are projected to remain below the average in the EU up to 2050. A further increase in the employment rate of older workers than assumed in the projections would contribute to reduce the projected relatively marked decrease in the benefit ratio. Indeed, a large increase in employment rates for older workers would foster GDP growth and ensure that workers can accumulate enough pension rights to limit the decrease in the benefit ratio, which would reduce the risks of possible pressures on the public finance emerging in the future.
As underlined by the 2005/06 update of the stability programme, the increase in contribution years necessary to be entitled to a full pension, through an automatic rule meant to keep up to 2020 the ratio between the number of contribution years and the number of years in pension constant, is still subject to review after the opinion of an independent Commission in 2008 is put forward. It is therefore not clear at this stage if there will be any modification to the current increase in the contribution period and, if any, whether it will strengthen or soften eligibility criteria for a full pension.
Overall assessment
The long-term budgetary impact of ageing in France is slightly lower than the EU average; with pension expenditure showing a somewhat more limited increase than in many other countries, influenced by the pension reforms enacted in 1993 and 2003. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. Increasing the employment rates of older workers would improve workers' pensions in the future and ensure the success of the pension reforms.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Moreover, the current level of gross debt is above the Treaty reference value. Consolidating the public finances would therefore be key in view of reducing risks to the sustainability of public finances.
Overall, France appears to be at medium risk with regard to the sustainability of public finances.



 [pic] 
 Ireland 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Irish economy is projected to experience a slowdown of economic growth over the coming decades, from 5.5% during 2004-2010 to 3.3% in 2011-2030 and a further decline to 1.6% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[119] The old-age dependency ratio is projected to rise from 16% in 2004 to 45% in 2050, a higher rise than on average in the EU.
The projected increase in age-related spending is well above the average of the EU, rising by 7.8% points of GDP between 2004 and 2050. Most of the projected increase during this period is due to the high increase in pension expenditures, of 6.4% points of GDP. The increase in expenditure on health-care is projected to be 2% points of GDP higher than on average in the EU, while on long-term care a rise of 0.6% points of GDP is projected, coinciding with the average in the EU.
Irish public finances have been sound in the recent past and in 2005 a surplus of 1.0% of GDP was noted, better than 0.3% of GDP expected in the stability programme. This has enabled a reduction of the debt/GDP ratio, which has fallen by almost 8% of GDP in four years, to reach 27.6% of GDP in 2005, and accumulation of assets in the national pension reserve fund. The Irish 2005 stability programme aims for a deficit of 0.8% of GDP in 2008. The MTO set in the stability programme to close to balance in structural terms and the Irish authorities plans to maintain a structural position that satisfies the MTO throughout the programme period. The structural balance was estimated in the Commission services spring 2006 forecast to a surplus of 1.9% of GDP in 2005. Attaining the MTO in 2010 thus implies a weakening of the fiscal position of almost 2% points of GDP. According to spring forecast, a deficit of 0.4% of GDP is expected in 2007 on the basis of the current policies, slightly stronger than the programme's forecast of 0.8%, suggesting that budgetary outcomes could be better than projected in the programme. However, it should be also noted that the medium-term budgetary projections could be vulnerable if the downside macroeconomic risks, notably stemming from a downturn in the housing sector, were to be realised.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Ireland has a sustainability gap of 2.9% of GDP in the baseline scenario. The long-term budgetary impact of ageing is significantly above the EU average, reflecting notably a relatively high increase in pension expenditure as a share of GDP over the long term, influenced in part by the maturing of the pension system.
The initial budgetary position, with a high structural primary balance of 3.1% of GDP in 2005, contributes to reducing debt and enables the continued accumulation of assets in public pension schemes over the medium term. Assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance becomes smaller, falling from 3.1% in 2005 to 0.8% of GDP in 2010. Such a reduction in the structural primary balance of more than 2% of GDP would have a negative impact on the sustainability gap, the gap rising to 5.3% of GDP in the MTO scenario. This shows that maintaining a high structural primary surplus over the medium term is key to reducing risks to the long-term sustainability of public finances
Pension policy is currently under review in Ireland. The Pensions Board recently launched the National Pensions Review , covering overall pension arrangements.[120] The Review raised a number of issues, including among others that a significant increase is predicted in the annual costs of social welfare retirement pensions and public service pensions and that supplementary pension coverage is currently insufficient and a cause for concern. Against that background, and in the context of the forthcoming planned Social Partnership Agreement , the Government has committed itself to the early publication of a Green Paper on pensions policy and to develop a framework for "comprehensively addressing the pensions agenda over the longer-term".[121]
It should be noted that the Irish authorities project a higher increase in health-care expenditures over the long term compared with the reference scenario, by about 1% of GDP, suggesting that the budgetary cost of ageing could be even higher.
Overall assessment
The long-term budgetary impact of ageing in Ireland is well above the EU average, as a result of a relatively high increase in pension expenditure as a share of GDP over the coming decades, influenced in part by the maturing of the pension system.
The initial budgetary position with a high primary surplus contribute to ease the projected long-term budgetary impact of ageing populations, but is not sufficient to fully cover the substantial increase in expenditure due to the ageing of the population. Maintaining high primary surpluses over the medium term and implementing measures aimed at curbing the significant increase in age-related expenditures would be key to reducing risks to the sustainability of public finances.
Overall, Ireland appears to be at medium risk with regard to the sustainability of public finances.
[pic] 
 Italy 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Italian economy is projected to experience a slowdown of economic growth over the coming decades, from 1.9% during 2004-2010 to 1.5% in 2011-2030 and a further decline to 0.9% in 2031-2050, influenced by an ageing population.[122] The old-age dependency ratio is projected to rise from 29% in 2004 to 62% in 2050, a significantly higher rise than on average in the EU.
The projected increase in age-related spending in Italy is below the average of the EU; rising by 1.7% points of GDP between 2004 and 2050. The increase in expenditure on pensions is projected to be limited in Italy, rising by 0.4% points of GDP due to large reforms enacted in the past, including the reform approved in 2004. This reform tightens sharply eligibility conditions for early pensions as from 2008. Moreover, the projections hinge upon the implementation of the planned periodical actuarial updates which adjust pension entitlements to life expectancy, the first was due in 2005, but was postponed. The increase in health-care expenditure is projected to be 1.3% points of GDP, lower than on average in the EU, while on long-term care an increase of 0.4% points of GDP is projected, close to the average in the EU.
Italy has been placed in excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2007. In 2005, the deficit was 4.1% of GDP, after having been above 3% since 2003. As a result of a shrinking primary surplus in recent years, the debt/GDP ratio after declining in the past ten years, has started rising again in 2005 to reach 106.4% of GDP and is projected to rise further in 2006 and, in the no-policy change scenario, in 2007. The Italian 2005 stability programme plans a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.5% of GDP in 2009. The adjustment towards the MTO set in the stability programme at balance in structural terms is expected in the programme to be achieved beyond the programme period. According to the Commission services 2006 spring forecast a deficit of 4.5% of GDP is expected in 2007 on the basis of the current policies, below the programme's target of 2.8%, suggesting that a significant additional correction would be needed to meet this target.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Italy has a sustainability gap of 3.1% of GDP in the baseline scenario. The long-term budgetary impact of ageing is lower than the EU average, influenced by pension reforms enacted that limit the increase in pension expenditure as a share of GDP.
The initial budgetary position with a structural primary balance of 0.6% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance improves; rising from 0.6% in 2005 to 4.5% of GDP in 2010. The higher structural primary balance in 2010 would have a considerable positive impact on the sustainability gap; eliminating it in the MTO scenario (-1.1% of GDP). This shows the importance of strengthening the structural primary surplus over the medium-term so as to reduce sustainability risks.
Moreover, the current level of debt is very high, above 100% of GDP. Ensuring a reduction of debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce risks to public finance sustainability. Indeed, an increase of the discount rate by one percentage point would increase the sustainability gap by 0.8% of GDP, notably due to the very high level of debt and accompanying high debt servicing costs.
Data on pension expenditure incorporate the impact of the reform approved in July 2004. Pension expenditure is projected to be below the pre-reform scenario by 0.6-0.7% of GDP for the next thirty years. The reform tightens sharply eligibility conditions for early pensions as from 2008, introducing different treatment of workers belonging to contiguous age groups. Discussions are ongoing on how to distribute the increase in retirement age more evenly, possibly anticipating it in the light of the need to consolidate public finances.
The benefit ratio in Italy is projected to decrease relatively markedly, by around 30% in the period to 2050, despite a large increase in the employment rate of older workers. Indeed, although employment rates of older workers are currently lower in Italy (29%) than on average in the EU (40%) the gap is projected to narrow in the future. A further increase in the employment rate of older workers than assumed in the projections would contribute to reduce the projected relatively marked decrease in the benefit ratio. Indeed, a large increase in employment rates for older workers, more than already factored into the projections, would foster GDP growth and ensure that workers can accumulate enough pension rights to limit the decrease in the benefit ratio, which would reduce the risks of possible pressures on public expenditure emerging in the future. A measure establishing a second pillar pension scheme for private sector workers was approved in November 2005, but its implementation has been delayed until 2008. The measure implies the transfer of the end of service allowance ( trattamento di fine rapporto - TFR ) to occupational pension schemes.
Overall assessment
The long-term budgetary impact of ageing in Italy is lower than the EU average, with pension expenditure showing a more limited increase than on average in the EU, influenced by the pension reforms enacted and assuming that the full impact of the pension reforms, notably the planned periodical actuarial adjustment in line with life expectancy, will be implemented. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future cannot be excluded. Increasing the employment rates of older workers would improve workers' pensions in the future and ensure the success of the pension reforms.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Moreover, the current level of gross debt is well above the Treaty reference value and reducing it requires achieving high primary surpluses for a long period of time, which would be key in view of reducing risks to the sustainability of public finances.
Overall, Italy appears to be at medium risk with regard to the sustainability of public finances.


[pic] 
 Cyprus
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Cypriot economy is projected to experience a slowdown of economic growth over the coming decades, from 4.3% during 2004-2010 to 3.5% in 2011-2030 and a further decline to 1.9% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[123] The old-age dependency ratio is projected to rise from 17% in 2004 to 43% in 2050, a higher increase than on average in the EU.
The projected increase in age-related spending in Cyprus is highest in the EU; rising by 11.8% points of GDP between 2004 and 2050. This is predominantly due to a very high rise in pension expenditure, projected to show the highest increase in the EU of 12.9% points of GDP. The increase in expenditure on health-care is projected to be 1.1% points of GDP, below the average in the EU. No projections of long-term care expenditure are available in the Ageing Report.
Cyprus has consolidated the public finances in the recent past; after having been above 3% of GDP since 2002, the deficit was brought below the 3% of GDP reference value in 2005 and it stood at 2.4% of GDP. As a result, the Commission recommended in June 2006 that the Decision on the existence of an excessive deficit should be abrogated. The reduction of the deficit has facilitated a stabilisation of the debt/GDP ratio, which however remains high at 70.3% of GDP in 2005. The budgetary strategy outlined in the convergence programme projects a gradual strengthening of the public finances over the medium-term, and the MTO set in the stability programme at a deficit of 0.5% of GDP in structural terms is expected to be almost reached by 2009. According to the Commission services 2006 spring forecast a deficit of 2% of GDP is expected in 2007 based on no-policy change scenario, close to the programme's forecast of 1.8% of GDP, suggesting the budgetary plans in the programme are attainable.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Cyprus has a very large sustainability gap of 8.5% of GDP in the baseline scenario. The long-term budgetary impact of ageing is among the highest in the EU, reflecting a very high increase in pension expenditure as a share of GDP.
The initial budgetary position, with a structural primary balance of 0.5% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of a structural balance of -0.5% of GDP is reached in 2010, the structural primary balance improves; rising from 0.5% in 2005 to 2% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap; however, the gap would still be very high, at 6.9% of GDP in the MTO scenario.
The current level of debt is higher than 60% of GDP and ensuring a reduction of debt to below the debt reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce risks to public finance sustainability.
Overall assessment
The long-term budgetary impact of ageing in Cyprus is among the highest in the EU, influenced notably by a very large increase in pension expenditure as a share of GDP.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Moreover, the current level of debt is higher than 60% of GDP. Continuing the consolidation of the public finances simultaneously with adopting pension reform measures aimed at containing the significant increase in age-related expenditures will be necessary, as recognised by the authorities, and would be key in view of reducing risks to the sustainability of public finances.
Overall, Cyprus appears to be at high risk with regard to the sustainability of public finances.
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 Latvia 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Latvian economy is projected to experience a significant slowdown of economic growth over the coming decades, from 7.7% during 2004-2010 to 3.4% in 2011-2030 and a further decline to 1.1% in 2031-2050, influenced by the ageing of its population and an assumed slowdown of labour productivity growth.[124] The old-age dependency ratio is projected to rise from 24% in 2004 to 44% in 2050, albeit a smaller increase than on average in the EU.
Age-related spending is projected to fall by 1.3% points of GDP in Latvia between 2004 and 2050, the second largest decrease in the EU. This is mainly due to a projected fall in public expenditure on pensions by 1.2% points of GDP, as a result of a comprehensive pension reform. The pension system consists of notional individual accounts, introduced in 1996, and a mandatory funded defined contribution scheme, implemented in 2001. The increase in expenditure on health-care is projected to be 1.1% points of GDP, below the average in the EU. For long-term care an increase of 0.3% points of GDP is projected, lower than on average in the EU.
Latvian public finances have strengthened in the recent past and in 2005 a surplus of 0.2% of GDP was recorded, considerably better than the deficit of 1.5% of GDP expected in the 2005 convergence programme. As a result, the debt/GDP ratio has been reduced slightly over the last four years, standing at 11.9% of GDP in 2005. The Latvian 2005 convergence programme targets a deficit of 1.3% of GDP in 2008, close to the MTO of a deficit of 1% of GDP set in structural terms, the latter also being expected to be achieved by 2008. According to the Commission services 2006 spring forecast, a deficit of 1.0% of GDP is expected in 2007 on the basis of the current policies, slightly better than the programme's forecast of 1.4%, suggesting that the budgetary plans in the programme are attainable.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long term, Latvia has a sustainability gap of 0.8% of GDP in the baseline scenario. The long-term budgetary impact of ageing is well below the EU average, reflecting a limited increase in pension expenditure as a share of GDP over the long term, influenced by the pension reforms already enacted.
The initial budgetary position with a structural primary balance of 0.5% of GDP in 2005, if maintained, contributes to ease the long-term budgetary impact of ageing. Moreover, the current level of debt is very low, at 11.9% of GDP in 2005. Assuming that the MTO of -1% of GDP in structural terms is reached in 2010, the structural primary balance deteriorates; falling from 0.5% of GDP in 2005 to -0.6% of GDP in 2010. The lower structural primary balance in 2010 would increase the sustainability gap to 1.9% of GDP.
Overall assessment
The long-term budgetary impact of ageing in Latvia is lower than the EU average, with pension expenditure showing a more limited increase than in many other countries, influenced by the pension reforms already enacted.
The current level of gross debt is very low in Latvia and maintaining sound government finances, with very limited deficits, would contribute to contain the risks to the long-term sustainability of public finances.
Overall, Latvia appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Lithuania
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Lithuanian economy is projected to experience a slowdown of economic growth over the coming decades, from 6.5% during 2004-2010 to 3.3% in 2011-2030 and a further decline to 1.1% in 2031-2050, influenced by ageing populations and an assumed slowdown of labour productivity growth.[125] The old-age dependency ratio is projected to rise from 22% in 2004 to 45% in 2050, albeit a smaller increase than on average in the EU.
The projected increase in age-related spending in Lithuania is well below the average in the EU; rising by 1.4% points of GDP between 2004 and 2050. This is particularly due to a limited increase in pension expenditure, being projected to rise only by 1.8% points of GDP, as a result of a comprehensive pension reform. The pension system consists of a PAYG scheme and a compulsory funded defined contribution scheme, the latter enacted in 2004. The increase in expenditure on health-care is projected to be 0.9% points of GDP, lower than on average in the EU. For long-term care an increase of 0.4% points of GDP is projected, below the average in the EU.
The Lithuanian public finances have been showing limited deficits in the recent past; in 2005, a deficit of 0.5% of GDP was recorded, better than the 1.5% of GDP expected in the December 2005 update of the convergence programme. The debt/GDP ratio has been reduced slightly over the last four years, standing at 18.7% of GDP in 2005. The updated Lithuanian 2005 convergence programme sets as MTO reducing the general government deficit in structural terms to or below 1% of GDP by 2008 and foresees that the headline deficit will reach also a level of 1% of GDP in 2008. According to the Commission services 2006 spring forecast, the deficit is expected to increase to 0.9% of GDP in 2007 assuming a no-change policy scenario and including the impact of a decrease in personal income tax and increasing costs of pension reform. Nevertheless, this is higher than the programme's forecast of 1.3% for 2007, suggesting that budgetary outcomes could be slightly better than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Lithuania has a sustainability gap of 1.8% of GDP in the baseline scenario. The long-term budgetary impact of ageing is well below the EU average, reflecting a limited increase in pension expenditure as a share of GDP over the long-term, influenced by the pension reforms enacted.
The initial budgetary position with a structural primary balance of -0.3% of GDP in 2005 is insufficient to prevent unsustainable public finances over the long-term. However, the current level of debt is very low. Assuming that the MTO of -1% of GDP in structural terms is reached in 2010, the structural primary balance remains unchanged at -0.3% of GDP, as does the sustainability gap at 1.8% of GDP.
Further changes to the pension systems are envisaged. Starting from 2012, the retirement age is planned to be increased by 2 months for men and 4 months for women every year until it reaches 65 years for both men and women in 2026 (from 60 years for women and 62.5 years for men in 2006). This envisaged measure aims both at ensuring the financial sustainability of the pension system and increasing the replacement rates for pensioners.
Overall assessment
The long-term budgetary impact of ageing in Lithuania is lower than the EU average, with pension expenditure showing a more limited increase than in many other countries, influenced by the pension reforms enacted.
The current level of gross debt is very low in Lithuania and maintaining sound government finances, with very limited deficits, would contribute to contain the risks to the long-term sustainability of public finances.
Overall, Lithuania appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Luxembourg
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', Luxembourg is projected to experience a slowdown of economic growth over the coming decades, from 4% during 2004-2010 to 3% in 2011-2030 and in 2031-2050, influenced by ageing populations.[126] The old-age dependency ratio is projected to rise from 21% in 2004 to 36% in 2050, among the smallest increases in the EU.[127]
The projected increase in age-related spending in Luxembourg is among the five highest increases in the EU, rising by 8.2% points of GDP between 2004 and 2050. This is particularly due to pension expenditure being projected to rise considerably more than on average in the EU, by 7.4% points of GDP. This is considerably higher than projected in 2001 by the EPC, which projected an increase of 1.9% points of GDP between 2005 and 2050. The 2002 revalorisation of social security pensions and the inclusion of civil servants’ pensions may explain part of such increase. Moreover, since the 2001 projection exercise, further analysis has been carried out at the national level to better take into account cross-borders workers and lengthening careers of women. Indeed, over the last two decades Luxembourg has experienced a period of exceptionally strong employment growth which will progressively translate into a similar increase in the number of pensioners and into a large increase in pension expenditure, influenced by a large number of cross-border workers. The increase in expenditure on health-care is projected to be 1.2% points of GDP, lower than on average in the EU, while on long-term care an increase of 0.6% points of GDP is projected, coinciding with the average in the EU.
In Luxembourg, a deficit of 1.9% of GDP was recorded in 2005, a slightly higher deficit than in the previous year following a period of consecutive surpluses in public finances. The gross debt/GDP ratio has remained very small in Luxembourg, standing at 6.2% of GDP in 2005. Moreover, considerable assets have been accumulated by social security. Luxembourg’s 2005 stability programme projects a gradual strengthening of the public finances over the medium-term, and the MTO set in the stability programme at deficit of 0.8% of GDP in structural terms is expected in the programme to be achieved in 2008. According to the Commission services 2006 spring forecast a deficit of 1.5% of GDP is expected in 2007 on the basis of the current policies, below the programme's forecast of 1%, suggesting that budgetary outcomes could be slightly worse than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Luxembourg has a sustainability gap of 9.5% of GDP in the baseline scenario.[128] The long-term budgetary impact of ageing is among the highest in the EU reflecting notably a relatively high increase in pension expenditure as a share of GDP over the long-term.
While the current level of gross debt is very low in Luxembourg, the initial budgetary position, with a weak structural primary balance of -1.2% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of -0.8% of GDP in structural terms is reached in 2010, the structural primary balance improves; rising from -1.2% in 2005 to -0.5% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap; however, it would remain high at 8.9% of GDP in the MTO scenario.
Several measures were decided by a "tripartite agreement" (employers, trade unions and government) at the end of April 2006 in order to bring public finance back to balance over the next coming years. They include a rise in several taxes and social contributions as well as measures that aim at curbing the increase in spending, which has been very fast in recent years. The most important of these measures is the suspension of the "normal" indexation of wages and social benefits on consumer prices up to 2009, which will be replaced by a system where indexation threshold are set beforehand about once a year.
Overall assessment
The long-term budgetary impact of ageing in Luxembourg is among the highest in the EU, influenced notably by a very considerable increase in pension expenditure as a share of GDP over the coming decades.
The current level of gross debt is very low in Luxembourg and considerable assets have been accumulated in social security. However, while the current size of social security assets contributes significantly to public finance sustainability, it will not be sufficient to offset the sizeable increase in age-related expenditure. Therefore, as recognised by the authorities, some changes to the pension schemes will prove necessary at some point so as to contain future increase in public expenditure and reduce the risk to the long-term sustainability of public finances.
Overall, Luxembourg appears to be at medium risk with regard to the sustainability of public finances.
[pic] 
 Hungary 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Hungarian economy is projected to experience a slowdown of economic growth over the coming decades, from 3.7% during 2004-2010 to 2.6% in 2011-2030 and a further decline to 1.1% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[129] The old-age dependency ratio is projected to rise from 23% in 2004 to 48% in 2050, close to the average in the EU.
The projected increase in age-related spending is well above the average in the EU; rising by 7.6% points of GDP between 2004 and 2050. Most of the projected increase during this period is due to the high increase in pension expenditures of 6.7% points of GDP. The increase in expenditure on health-care is projected to be 1% point of GDP, below the average in the EU. An increase of 0.6% points of GDP is projected for expenditure on long-term care, the same rise as on average in the EU.
In the calculations, the Hungarian government revenues are reduced by the revenue-reducing impact of Eurostat's decision on the classification of funded defined contribution pension schemes that will take effect from 2007 onwards. The MTO is assumed to be -1% of GDP in the MTO scenario (see Chapter III for further information). The figures with this adjustment are given in brackets in this part.
Hungary has been placed in the excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2008 at the latest. The deficit was 6.1% (7.5%) of GDP in 2005, after having been above 3% for the last four years. As a result of the weak fiscal position in recent years, the debt/GDP ratio has risen by almost 7% of GDP in four years, to reach 58.4% (62.4%) of GDP in 2005. The Hungarian 2005 convergence programme projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.9% (3.4%) of GDP in 2007. The adjustment towards the MTO set in the convergence programme at -0.5% to -1% of GDP in structural terms is expected to be achieved beyond the programme period. According to the Commission services 2006 spring forecast a deficit of 7% (8.4%) of GDP is expected in 2007 on the basis of the current policies, well above the programme's forecast of 3.3% (4.8%) of GDP, suggesting that budgetary outcomes could be significantly worse than expected.[130]
Main findings and results
On the basis of end-2005 budgetary position and the projected budgetary changes over the long-term, Hungary has a large sustainability gap of 9.8% of GDP in the baseline scenario. The long-term budgetary impact of ageing is well above the average in the EU, reflecting a significant increase in pension expenditure as a share of GDP.
The initial budgetary position, with a structural primary balance of -2.5% (-3.6%) of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of -1% of GDP in structural terms is reached in 2010, the structural primary balance improves; rising from -3.6% in 2005 to 2% of GDP in 2010 (including the cost of the reclassification of the pension reform). The higher structural primary balance in 2010 would have a positive impact on the sustainability gap; however, the gap would still be 4.0% of GDP in the MTO scenario.
Overall assessment
The long-term budgetary impact of ageing in Hungary is well above the EU average, influenced notably by a significant increase in pension expenditure as a share of GDP over the long-term.
Moreover and importantly, the initial budgetary position is very weak: the very high structural deficit constitutes a risk to sustainable public finances even before considering the long-term budgetary impact of an ageing population. Carrying out a large consolidation of the public finances over the medium-term as planned, further strengthening the budgetary position thereafter, and addressing the significant increase in pension expenditure is therefore necessary in view of reducing risks to the sustainability of public finances.
Overall, Hungary appears to be at high risk with regard to the sustainability of public finances. 

[pic] 
 Malta
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Maltese economy is projected to experience a mild slowdown of economic growth over the long term; after average real GDP growth of 2.2% during the period 2004-2010, an increase to 2.8% in 2011-2030 is projected, followed by a decline to 2% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[131] The old-age dependency ratio is projected to rise from 19% in 2004 to 41% in 2050, albeit a smaller increase than on average in the EU.
The projected increase in age-related spending in Malta is well below the average in the EU; rising by 0.3% points of GDP between 2004 and 2050. This is mainly due to a projected fall in public expenditure on pensions by 0.4% points of GDP, as a result of the specific design of the Maltese pension system, which, in effect puts a cap on the level of both pensions and contributions, which are projected to fall as a share of GDP between the 2020s and 2050. The increase in expenditure on health-care is projected to be 1.8% points of GDP, close to the average in the EU, while on long-term care an increase of 0.6% points of GDP is projected, below the average in the EU.
Malta has been placed in the excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2006 at the latest. The deficit was 3.3% in 2005, after having been above 3% for the last four years. As a result of the weak fiscal position in recent years, the gross debt/GDP ratio has increased by almost 7% of GDP over the last four years and was 74.7% of GDP in 2005, above the Treaty reference value. The budgetary strategy outlined in the convergence programme projects a gradual strengthening of the public finances over the medium-term and the MTO set in the convergence programme at balance in structural terms is expected to be achieved in 2008. According to the Commission services 2006 spring forecast, a deficit of 3.2% of GDP is expected in 2007 on the basis of the current policies, well above the programme's forecast of 2.3% of GDP, suggesting that budgetary outcomes could be worse than expected.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Malta does not have a sustainability gap in the baseline scenario (S2 is -0.3% of GDP). The long-term budgetary impact of ageing is close to zero and is the third lowest in the EU, influenced notably by the design of the pension system.
The initial budgetary position with a structural primary balance of 0.9% of GDP in 2005 is insufficient to result in a steady reduction of the debt/GDP ratio. Assuming that the MTO of balance in structural terms is reached in 2010, the structural primary balance improves; rising from 0.9% of GDP in 2005 to 3.6% of GDP in 2010. The higher structural primary balance in 2010 would reduce the sustainability gap. This shows the importance of strengthening the structural primary surplus over the medium-term to reduce sustainability risks.
The current level of debt is higher than 60% of GDP and it has been increasing in recent years. Ensuring a reduction of debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce risks to public finance sustainability.
The benefit ratio in Malta is projected to decrease markedly, by about 45% in the period to 2050. Indeed, under current legislation, pensions are indexed to wage growth but are also subject to a maximum which grows in line with the Cost Of Living Adjustment (COLA), which in turn increases more slowly than the inflation rate. This implies a very slow growth of individual pensions such that pension expenditure will fall as a share of GDP after 2020 despite an increasing number of pensioners. Moreover, the current pension system contains a similar ceiling on income which is subject to pension contributions. Currently, this ceiling is 33% higher than the average wage and increases with the COLA index. Given that real wages will grow in line with productivity, average wages will increase more rapidly than the ceiling. As more wages approach the ceiling, the share of wages subject to pension contributions will decrease relative to GDP. As a result, the revenue of the pension schemes will decrease as a share of GDP over the projection period. As a consequence, despite the profile of pension expenditure, the pension system will show an increasing deficit, reaching 5% of GDP in 2020 and improving somewhat thereafter to a deficit of around 4% of GDP. Indeed, the projections in the 2005 convergence programme update show a deficit in the pension system over the long term.
Pension policy is currently under review in Malta. Following the government’s White Paper ‘Pensions Adequate and Sustainable’, released in November 2004, the Pensions Working Group proposed a wide range of reform options in their June 2005 report with regard to improving the Maltese pension system. The report reaches the conclusion that the option of ’no reform’ is not a solution. The government has announced a pension reform in March 2006.[132] The main points of the proposed reform are: (i) the retirement age will increase from the current 61 years to 65 in a gradual manner; (ii) raising the future minimum pension compared with the current system; (iii) the period for which contributions have to be paid will increase to 40 years (from 30 years before) in a gradual manner; (iv) increasing the highest pension, which will rise in line with inflation or according to a periodic revision. An analysis will be carried out every five years to assess the state of the pension system and to implement revisions accordingly. The first revision will be carried out in 2010.
Overall assessment
The long-term budgetary impact of ageing in Malta is among the lowest in the EU, with pension expenditure falling as a share of GDP over the long-term. This is due to the specific design of the pension system, which puts a cap on the level of pensions and is projected to result in a fall of pension expenditure as a share of GDP. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. The Maltese authorities have announced a pension reform, aiming at ensuring adequacy and sustainability of the pension system.
The initial budgetary position is not sufficient to prevent a steady reduction of the gross debt ratio, which is necessary in order to reduce debt to below the Treaty reference value. Consolidating the public finances and implementing measures to ensuring adequacy and sustainability of the pension system would therefore be key in view of reducing risks to the sustainability of public finances.
Overall, Malta appears to be at medium risk with regard to the sustainability of public finances.
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 The Netherlands 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Dutch economy is projected to experience relatively stable economic growth over the coming decades, at 1.7% during 2004-2010, 1.6% in 2011-2030 and 1.7% in 2031-2050, despite an ageing population.[133] The old-age dependency ratio is projected to rise from 20% in 2004 to 41% in 2050, albeit a smaller rise than on average in the EU.
The projected increase in age-related spending in the Netherlands (5% points of GDP between 2004 and 2050) is higher than the average of the EU. This is particularly due to pension expenditure being projected to rise more than on average in the EU, by 3.5% points of GDP, although the recent reform of the disability scheme contributes to curb long-term public spending. The increase in expenditure on health-care is projected to be 1.3% points of GDP, slightly lower than on average in the EU, while on long-term care an increase of 0.6% points of GDP is projected, close to the average in the EU.
The Netherlands achieved a considerable improvement of the public finances in the recent past; a small deficit of 0.3% of GDP was recorded in 2005, after a deficit of 3.1% of GDP in 2003. This was almost 1% of GDP better than expected in the 2005 stability programme. The improvement in the budgetary position contributed to stabilise the debt/GDP ratio, at 52.9% of GDP in 2005. The Dutch 2006 stability programme projects that the public finances will show a small deficit over the medium-term, aiming at a deficit of 1.1% of GDP in 2008. The structural balance projected in the programme satisfies the MTO set at between –0.5% and –1% of GDP in structural terms throughout the programme period to 2008. According to the Commission services 2006 spring forecast a deficit of 0.7% of GDP is expected in 2007 on the basis of the current policies, below the programme's forecast of 1.2%, suggesting that budgetary outcomes could be better than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, the Netherlands has a sustainability gap of 1.3% of GDP in the baseline scenario. The long-term budgetary impact of ageing is higher than the EU average, reflecting notably a relatively high increase in pension expenditure as a share of GDP over the long-term.
The initial budgetary position, with a currently high structural primary balance of 3.6% of GDP in 2005 contributes to reducing debt, which will on current policies continue over the medium-term. Assuming that the MTO set as a structural deficit between -0.5% and -1% of GDP is attained in 2010, the structural primary balance becomes smaller; falling from 3.6% in 2005 to 1.4% of GDP in 2010. The reduction of the structural primary balance in 2010 of more than 2% of GDP would have a negative impact on the sustainability gap, rising to 3.6% of GDP in the MTO scenario. This shows that maintaining a high structural primary surplus over the medium-term is key to reduce risks to the long-term sustainability of public finances.
According to Dutch long-term projections, revenues are projected to increase over the long-term, mainly due to deferred taxation of pension disbursements and an increase in VAT as a share of GDP. This impact is important in the Netherlands, as private pension schemes currently hold large assets (around 135% of GDP in 2004) and are expected to accumulate them further since for the next two decades, contributions to these schemes should still be higher than the corresponding pension outlays.
However, general government property income in the Netherlands, consisting of both revenues from financial assets and from natural resources, amounted to 2.3% of GDP in 2005 which is higher than the EU average. As shown in Chapter IV, risks to public finance sustainability might be underestimated by around half of this amount. According to Dutch projections health-care expenditures could rise faster than the common projections, by 2% of GDP, as different assumptions regarding the main drivers of health-care costs are used, which would more than offset the positive impact of the projected increase in revenues. Overall, these additional projections do not significantly alter the outlook for the long-term sustainability of the Dutch public finances.
Finally, the considerable assets, already accumulated in private pension schemes, will contribute strongly to the income of pensioners in the future. Indeed, occupational and private mandatory pensions will almost double as a share of GDP (from 4.6% in 2004 to 8.7% of GDP in 2050). This should enable to maintain a total (public and private) benefit ratio at its current level over the long-term.
Overall assessment
The long-term budgetary impact of ageing in the Netherlands is higher than the EU average, influenced notably by a relatively high increase in pension expenditure as a share of GDP over the coming decades.
The initial budgetary position with a relatively high structural primary surplus contributes to ease the projected long-term budgetary impact of an ageing population, but it is not sufficient to fully cover the substantial increase in age-related expenditure. The projected future rise of revenues as a share of GDP, mainly due to deferred taxation of pensions, would partly compensate for the increase in public expenditure over the long-term. However, maintaining high primary surpluses over the medium-term would be key in view of containing risks to the sustainability of public finances.
Overall, the Netherlands appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Austria 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Austrian economy is projected to experience a slowdown of economic growth over the coming decades, from 2.2% during 2004-2010 to 1.6% in 2011-2030 and a further decline to 1.2% in 2031-2050, influenced by an ageing population.[134] The old-age dependency ratio is projected to rise from 23% in 2004 to 52% in 2050, a higher increase than on average in the EU.
The projected increase in age-related spending in Austria is among the smallest in the EU, rising by 0.2% points of GDP between 2004 and 2050. This small increase is particularly due to the large pension reforms of 2003 and 2004, which is projected to result in a fall in pension expenditure of 1.2% points of GDP over the long-term. The set of comprehensive reforms of the Austrian pension system in recent years has been finalised with the harmonisation of previously existing various pension schemes for different groups of the population, coming into force on 1 January 2005. Thus, a single pension system for most segments of the population with equal rules governing contributions and benefits has been established. Civil servants of the federal government under the age of 50 are integrated into the new system. The increase in expenditure on health-care is projected to be 1.6% points of GDP, coinciding with the average in the EU, while spending on long-term care is projected to rise by 0.9% points of GDP, slightly above the average in the EU.
The Austrian public finances have been showing relatively small deficits in the recent past; and a deficit of 1.5% of GDP was recorded in 2005, slightly better than expected in the 2005 stability programme. As a result, the debt/GDP ratio has been reduced slightly over the last four years, to 62.9% of GDP in 2005. The Austrian 2005 stability programme projects a gradual strengthening of the public finances over the medium-term, and the MTO set in the stability programme at balance in structural terms is expected in the programme to be achieved in 2008. According to the Commission services 2006 spring forecast a deficit of 1.4% of GDP is expected in 2007 on the basis of the current policies, below the programme's forecast of 0.8%, suggesting that budgetary outcomes could be worse than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Austria has a small sustainability gap of 0.3% of GDP in the baseline scenario. The long-term budgetary impact of ageing is well below the EU average, reflecting a limited increase in pension expenditure as a share of GDP over the long-term, influenced by the pension reforms enacted.
The initial budgetary position with a structural primary balance of 1.7% of GDP in 2005 contributes to ease the long-term budgetary impact of ageing. Assuming that the MTO set to balance in structural terms is reached in 2010, the structural primary balance improves; rising from 1.7% in 2005 to 2.4% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact and the sustainability gap would be eliminated (being -0.5% of GDP).
The benefit ratio in Austria is projected to decrease relatively markedly, by almost 30% in the period to 2050. Employment rates of older workers are currently lower in Austria (30%) than on average in the EU (40%), but are expected to increase more than on average in the EU up to 2050 to reach 58%, very close to the average of 59%. A further increase in the employment rate of older workers than assumed in the projections would contribute to reduce the projected relatively marked decrease in the benefit ratio. Indeed, a large increase in employment rates of older workers would foster GDP growth and ensure that workers can accumulate more pension rights.
The current level of debt is higher than 60% of GDP in Austria. Ensuring a reduction of the debt ratio to below the reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce public finance sustainability risks.
Overall assessment
The long-term budgetary impact of ageing in Austria is well below the EU average; with pension expenditure projected to fall over the long-term, influenced by the considerable expenditure-reducing impact of the reform of the pension systems. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. Increasing the employment rates of older workers would improve workers' pensions in the future and ensure the success of the pension reforms.
The initial budgetary position with a primary surplus contributes to the reduction of debt, currently above 60% of GDP, which is necessary. Maintaining sound government finances over the medium term would be key in view of limiting risks to the long-term sustainability of public finances.
Overall, Austria appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Poland 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Polish economy is projected to experience a slowdown of economic growth over the coming decades, from 4.6% during 2004-2010 to 3.2% in 2011-2030 and a further decline to 0.9% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[135] The old-age dependency ratio is projected to rise from 19% in 2004 to 51% in 2050, higher than on average in the EU.
Age-related spending is projected to fall by 6.7% points of GDP in Poland between 2004 and 2050. This is mainly due to a projected fall in public expenditure on pensions by 5.9% points of GDP as a result of a comprehensive pension reform enacted in 1999 when a notional defined contribution scheme was put into place, consisting of a notional defined contribution PAYG scheme and a private funded defined contribution scheme. The latter will be classified outside government from 2007 onwards. The increase in expenditure on health-care is projected to be 1.4% points of GDP, slightly below the average in the EU, while on long-term care a small rise of 0.1% points of GDP is projected, the lowest increase in the EU.
In the calculations, the Polish government finances are reduced by the revenue-reducing impact of Eurostat's decision on the classification of funded defined contribution pension schemes that will take effect from 2007 onwards. The MTO is assumed to be -1% of GDP in the MTO scenario (see Chapter III for further information). The figures with this adjustment are given in brackets in this part.
Poland has been placed in excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2007. The deficit was 2.5% (4.4%) of GDP in 2005, after having been above 3% of GDP for the last four years. As a result of the weak fiscal position in recent years, the debt/GDP ratio has risen by almost 7% of GDP in four years, to reach 42.5% of GDP in 2005. The Polish 2005 stability programme projects a slight strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.9% (3.8%) of GDP in 2008. The adjustment towards the MTO set in the convergence programme at -1% of GDP in structural terms is expected to be achieved beyond the programme period. According to the Commission services 2006 spring forecast a deficit of 3% (4.9%) of GDP is expected in 2007 on the basis of the current policies, above the programme's forecast of 2.2% (4.1%) of GDP, suggesting that budgetary outcomes could be worse than expected.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Poland has a no sustainability gap in the baseline scenario (S2 is -0.2% of GDP). The long-term budgetary impact of ageing is the lowest in the EU, influenced notably by the comprehensive pension reform implemented which results in a fall in pension expenditure as a share of GDP over the long-term.
Poland is however in a very specific position. The projected decrease in age-related expenditure as a share of GDP results in a negative long-term budgetary impact of ageing. This almost exactly offsets the weak initial budgetary position with a structural primary balance of -0.2% (-1.7%) of GDP in 2005. This implies that the weak initial budgetary position would result in an increase in the debt/GDP ratio over the medium-term, and that the projected future decrease in age-related expenditures as a share of GDP – assuming that the full impact of the pension reform materialises - would compensate for this and eventually stabilise the debt/GDP ratio. Assuming that the MTO of -1% of GDP in structural terms is reached in 2010, the structural primary balance improves; rising from –1.7% of GDP in 2005 to 1.6% of GDP in 2010 (including the cost of the reclassification of the pension scheme). The significantly higher structural primary balance in 2010 would have a considerable positive impact and eliminate the sustainability gap (being -3.7% of GDP in the MTO scenario).
The benefit ratio in Poland is projected to decrease markedly, by around 40% in the period to 2050.[136] Employment rates of older workers in Poland are currently considerably below the EU average (40%), but are projected to increase slightly more than on average in the EU. A further increase in the employment rate of older workers than assumed in the projections would contribute to reduce the projected relatively marked decrease in the benefit ratio. Indeed, a large increase in employment rates of older workers would foster GDP growth and ensure that workers can accumulate more pension rights.
Overall assessment
The long-term budgetary impact of ageing in Poland is the lowest in the EU, with age-related expenditure projected to fall over the long-term, influenced by the considerable expenditure-reducing impact of the reform of the pension system and assuming that the full impact of the pension reforms will be implemented. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. Increasing the employment rates of older workers would improve workers' pensions in the future and ensure the success of the pension reforms.
The initial budgetary position is not strong enough to prevent the risk of unsustainable public finances, influenced by the large revenue reducing impact of the pension reform; consolidating the public finances would help to contain risks to the sustainability of public finances.
Overall, Poland appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 Portugal
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Portuguese economy is projected to experience a slowdown of economic growth over the coming decades; after average growth of 1.9% during 2004-2010, it is projected to decline from 2.1% in 2011-2030 to 0.8% in 2031-2050, influenced by ageing populations.[137] The old-age dependency ratio is projected to rise from 25% in 2004 to 59% in 2050, among the largest increases in the EU.
The projected increase in age-related spending is well above the average of the EU, rising by 10.1% points of GDP between 2004 and 2050. Most of the projected increase during this period is due to the high increase in pension expenditures of 9.7% points of GDP. The increase in expenditure on health-care is projected to be 0.5% points of GDP, considerably below the average increase in the EU. An increase of 0.4% points of GDP is projected for expenditure on long-term care, a somewhat lower rise than on average in the EU.
Portugal has been placed in the excessive deficit procedure in September 2005 and is required to bring the deficit below 3% of GDP by 2008 at the latest. The government deficit jumped to 6% of GDP in 2005, after having been around 3% for the last four years, albeit with recourse to large one-off operations. As a result of the weak fiscal position in recent years, the government debt-to-GDP ratio has risen by more than 10 p.p. of GDP in four years, to reach 63.9% of GDP in 2005. The Portuguese December 2005 stability programme update projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.5% of GDP in 2009. The adjustment towards the MTO set in the stability programme of "at least -0.5% of GDP" is expected to be achieved beyond the programme period. According to the Commission services 2006 spring forecast a deficit of 4.9% of GDP is expected in 2007 on the basis of the current policies, above the programme's target of 3.7% of GDP, suggesting the existence of significant risks and uncertainties attached to the corrective measures that have been adopted since mid-2005 as well as the need of a very substantial effort to achieve the deficit reduction targets.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Portugal has a large sustainability gap of 10.5% of GDP in the baseline scenario. The long-term budgetary impact of ageing is well above the EU average, essentially reflecting a significant increase in pension expenditure as a share of GDP.
The initial budgetary position, with a structural primary balance of -2.5% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of -0.5% of GDP in structural terms is reached in 2010, the structural primary balance improves, rising from -2.5% in 2005 to +2.5% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap; however, the gap would still be 5.2% of GDP in the MTO scenario.
In April 2006, the Portuguese government presented in parliament five principles for the reform of the general pension scheme. The principles are as follows: (i) include an actuarial element by linking outlays to the beneficiary's residual life expectancy and payments into the system, together with the options to choose retirement age and higher contribution rates, rather than leaving the old-age benefit replacement rate as a function of the working career length only, as is currently the case; (ii) speed up the transition towards the new pension benefit formula decided in the 2002 reform (essentially, enlarging the assessment period to the entire career from the current rule of considering only the best 10 out of the last 15 working years); (iii) introduce an automatic link between annual benefits increases and nominal GDP growth, instead of deciding increases on an ad-hoc annual basis; (iv) differentiate contribution rates according to the contributor's family size in a regressive way, such that contributors with more (less) than two children will pay less (more); (v) expand coverage for disability, incapacity and survivors pensions and single-parent families.
These proposals are the basis for ongoing discussion with the social partners and are expected to underpin new legislation, whose first draft may come out over the summer and expected to be implemented by January 2007. While the proposals seem to be of help in promoting the sustainability of the pension system, a more thorough assessment can only be made on the basis of a detailed legislative proposal that would reveal how the envisaged changes will be implemented.
The current level of debt is higher than 60% of GDP in Portugal. Ensuring a reduction of debt to below the 60% of GDP reference value at a satisfactory pace is necessary so as to strengthen the resilience of the public finances to adverse shocks and to reduce public finance sustainability risks.
Overall assessment
The long-term budgetary impact of ageing in Portugal is well above the EU average, influenced notably by a significant increase in pension expenditure as a share of GDP over the long-term.
The weak initial budgetary position is insufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of ageing populations. Quickly achieving a marked and lasting medium-term consolidation of the public finances, continuing beyond the correction of the excessive deficit by the 2008 deadline, together with reform measures aimed at containing the significant increase in age-related expenditures would be key in view of reducing risks to the sustainability of public finances.
Overall, Portugal appears to be at high risk with regard to the sustainability of public finances. 

[pic] 
 Slovenia 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Slovenian economy is projected to experience a slowdown of economic growth over the coming decades, from 3.7% during 2004-2010 to 2.5% in 2011-2030 and a further decline to 1.1% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[138] The old-age dependency ratio is projected to rise from 21% in 2004 to 56% in 2050, a higher rise than on average in the EU.
The projected increase in age-related spending is well above the average of the EU; rising by 9.7% points of GDP between 2004 and 2050. Most of the projected increase during this period is due to the pension expenditure, rising by 7.3% points of GDP, among the highest increases in the EU. This is influenced by a modification of the pension indexation rule enacted in 2005 which partly offsets the expenditure-reducing impact of the 1999 pension reform. The increase in expenditure on health-care is projected to be 1.6% points of GDP coinciding with the average in the EU, while on long-term care a rise of 1.2% points of GDP is projected, higher than on average in the EU.
Slovenia has reduced the deficit by about 2½% of GDP over the last four years and a deficit of 1.8% of GDP was recorded in 2005, in line with plans in the December 2005 convergence programme. The debt/GDP ratio has remained broadly stable over the same period. The budgetary strategy outlined in the convergence programme aims at a gradual reduction of the deficit. The adjustment towards the MTO set in the convergence programme at -1% of GDP is expected to be achieved by 2008. According to the Commission services 2006 spring forecast a deficit of 1.6% of GDP is expected in 2007 on the basis of the current policies, close to the programme's forecast of 1.4%.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Slovenia has a sustainability gap of 7.3% of GDP in the baseline scenario. The long-term budgetary impact of ageing is well above the average in the EU, reflecting a considerable increase in pension expenditure as a share of GDP.
The initial budgetary position, with a structural primary balance of ¼% of GDP in 2005, contributes to stabilise the debt ratio over the medium-term, before considering the long-term budgetary impact of ageing. Assuming that the MTO of a structural balance of -1% of GDP is reached in 2010, the structural primary balance and the sustainability gap are broadly unchanged in the MTO scenario.
It should be noted that the Slovenian authorities' project a higher increase in health-care expenditures over the long-term compared with the reference scenario, of about 1½% of GDP, suggesting that the budgetary cost of ageing could be higher.
Overall assessment
The long-term budgetary impact of ageing in Slovenia is among the three largest increases in the EU, influenced notably by a considerable increase in pension expenditure as a share of GDP.
Although the initial budgetary position contributes to stabilise the debt ratio over the medium-term, it is not sufficient to cover the substantial increase in expenditure due to an ageing population. Further changes to the pension system will prove necessary at some point, as recognised by the Slovene authorities, so as to render the public finances sustainable over the long-term.
Overall, Slovenia appears to be at high risk with regard to the sustainability of public finances.
[pic] 
 Slovakia 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the economy of Slovakia is projected to experience a slowdown of economic growth over the coming decades, from 4.6% during 2004-2010 to 3.4% in 2011-2030 and a further decline to 0.6% in 2031-2050, influenced by an ageing population and an assumed slowdown of labour productivity growth.[139] The old-age dependency ratio is projected to rise from 16% in 2004 to 51% in 2050, a higher increase than on average in the EU.
The projected increase in age-related spending in Slovakia is lower than the average in the EU; rising by 2.9% points of GDP between 2004 and 2050. The increase in expenditure on pensions is projected to be relatively limited in Slovakia, rising by 1.8% points of GDP as a result of a pension reform. The pension system consists of a PAYG scheme and a funded defined contribution scheme, enacted in 2005. The increase in expenditure on health-care is projected to be 1.9% points of GDP, slightly above the average in the EU, while on long-term care an increase of 0.6% points of GDP is projected, coinciding with the average in the EU.
In the calculations, the Slovak government finances are reduced by the revenue-reducing impact of Eurostat's decision on the classification of funded defined contribution pension schemes that will take effect from 2007 onwards, estimated at 0.6% of GDP in 2005. The MTO is assumed to be -1% of GDP in the MTO scenario (see Chapter III for further information). The figures with this adjustment are given in brackets in this part.
Slovakia has been placed in the excessive deficit procedure and is required to bring the deficit below 3% of GDP by 2007 at the latest. The deficit was 2.9% (3.5%) in 2005, after having been above 3% for the last four years. The debt/GDP ratio has been reduced over the last four years by almost 9% of GDP and stood at 34.5% of GDP in 2005. The Slovak 2005 convergence programme projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.3% (2.7%) of GDP in 2008. The adjustment towards the MTO set in the stability programme at -0.9% of GDP in structural terms is expected to be achieved beyond the programme period, in 2010. According to the Commission services 2006 spring forecast, a deficit of 2.1% (3.4%) of GDP is expected in 2007 on the basis of the current policies, above the programme's forecast of 1.6% (3%) of GDP, suggesting that budgetary outcomes could be worse than expected.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Slovakia has a sustainability gap of 3% of GDP in the baseline scenario. The long-term budgetary impact of ageing is lower than the average in the EU, influenced by the pension reforms enacted.
The initial budgetary position with a structural primary balance of 0.2% (-0.4%) of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that the MTO of -1% of GDP in structural terms is reached in 2010, the structural primary balance improves; rising from –0.4% of GDP in 2005 to 0.8% of GDP in 2010 (including the impact of Eurostat's decision). The higher structural primary balance in 2010 would reduce the sustainability gap; though it would remain at 1.8% of GDP. This shows the importance of strengthening the structural primary surplus over the medium-term so as to reduce sustainability risks.
The benefit ratio in Slovakia is projected to decrease relatively markedly, by almost 20% in the period to 2050.[140] Employment rates of older workers are currently lower in Slovakia (25%) than on average in the EU (40%) and are projected to remain so up to 2050, although the gap is project to narrow. A further increase in the employment rate of older workers than assumed in the projections would contribute to reduce the projected relatively marked decrease in the benefit ratio. Indeed, a large increase in employment rates for older workers would foster GDP growth and ensure that workers can accumulate enough pension rights to limit the decrease in the benefit ratio, which would reduce the risks of possible pressures on the public finance emerging in the future.
In addition, property income in Slovakia amounted to 2% of GDP in 2005, which is above the EU average. As shown in Chapter IV, risks to public finance sustainability might be underestimated by around half of this amount, by around 1% of GDP. It should also be noted that the Slovak authorities project a slight reduction of child benefits (of some 0.1% point of GDP) up to 2050. Overall, these additional projections suggest that the risks to public finance sustainability could be slightly underestimated.
Overall assessment
The long-term budgetary impact of ageing in Slovakia is lower than the EU average, with pension expenditure showing a more limited increase than in many other countries, influenced by the pension reforms enacted. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. Increasing the employment rates of older workers would improve workers' pensions in the future and ensure the success of the pension reforms.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Given the large revenue reducing impact of the pension reform, projected to increase over the medium-term, consolidating the public finances would therefore be of key importance in view of reducing risks to the sustainability of public finances.
Overall, Slovakia appears to be at medium risk with regard to the sustainability of public finances.

 [pic] 
 Finland
Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the Finnish economy is projected to experience a slowdown of economic growth over the coming decades, from 2.7% during 2004-2010 to 1.7% in 2011-2030 and a further decline to 1.5% in 2031-2050, influenced by an ageing population.[141] The old-age dependency ratio is projected to rise from 23% in 2004 to 47% in 2050, albeit smaller than on average in the EU.
The projected increase in age-related spending is above the average of the EU; rising by 5.2% points of GDP between 2004 and 2050. Most of the projected increase during this period is due to pension expenditure, which is projected to increase by 3.1% points of GDP. The increase in expenditure on health-care is projected to be 1.4% points of GDP, slightly below the average in the EU, while on long-term care a rise of 1.8% points of GDP is projected, the highest increase in the EU.
The Finnish public finances have been sound in the recent past; with the government finances in surplus since the latter half of the 1990s and in 2005 a high surplus of 2.6% of GDP was noted, better than 1.8% of GDP expected in the 2005 stability programme. As a result of the strong fiscal position in recent years, the debt/GDP ratio has been reduced by 2% of GDP in four years to reach 41.1% of GDP in 2005; the limited decrease in the debt ratio is explained by a considerable accumulation of assets in the public pension schemes. The Finnish 2005 stability programme aims for a surplus of 1.5% of GDP in 2009. The MTO set in the stability programme at around 1½% of GDP is already more than attained with the better than expected fiscal outturn in 2005. According to the Commission services 2006 spring forecast a surplus of 2.5% of GDP is expected in 2007 on the basis of the current policies, above the programme's forecast of 1.5% of GDP, suggesting that budgetary outcomes could be better than projected in the programme.[142]
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Finland does not have a sustainability gap (S2 is -0.9% of GDP) in the baseline scenario. The long-term budgetary impact of ageing is higher than the EU average reflecting a relatively high increase in pension expenditure as a share of GDP over the long-term.
The initial budgetary position with a currently high structural primary balance of 4.7% of GDP in 2005 contributes to reducing debt and enables the continuation of accumulating assets in public pension schemes over the medium-term. Assuming that the MTO of a structural balance of 1.5% of GDP is attained in 2010, the structural primary balance becomes smaller; falling from 4.7% of GDP in 2005 to 2.3% of GDP in 2010; influenced in addition by interest expenditure on debt falling over the medium-term. The lower structural primary balance in 2010 would have a negative impact on the sustainability gap, rising to 1.6% of GDP in the MTO scenario.
According to Finnish national long-term projections, taxes on pensions are projected to increase by 1.3% of GDP between 2010 and 2050; which may further ease the increase in age-related expenditures over the long-term. The contribution rate is assumed to increase, raising public revenues by 1.6% points of GDP over the long-term. On the other hand, general government property income in Finland, consisting mainly of revenues from financial assets, amounted to 3.1% of GDP in 2005 which is higher than on average in the EU. As shown in Chapter IV, revenues from general government property income might be lower by about half of this amount over the long-term, suggesting that the risks to public finance sustainability might be underestimated. Moreover, a higher increase in expenditure on long-term care is projected by the Finnish authorities by about ¾% points of GDP higher than the common projections, suggesting that the budgetary cost of ageing could be higher. Overall, these additional projections do not significantly alter the outlook for the long-term sustainability of the Finnish public finances.
Finland has among the highest levels of taxation in the EU, suggesting that there is limited room of manoeuvre to meet expenditure increases by adjusting the budget on the revenue side.
Overall assessment
The long-term budgetary impact of ageing in Finland is higher than the EU average, influenced notably by the increase in pension expenditure as a share of GDP over the coming decades.
The initial budgetary position with a currently high primary surplus in 2005 would, if maintained, contribute significantly to ease the long-term budgetary impact of ageing. The large assets accumulated in the public pension fund contribute to finance part of the increase in pension expenditure. However, maintaining high primary surpluses over the medium-term would be key in view of containing risks to the sustainability of public finances.
Overall, Finland appears to be at low risk with regard to the sustainability of public finances.
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 Sweden 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report'[143], the Swedish economy is projected to experience a slowdown of economic growth over the coming decades, from 2.7% during 2004-2010 to 2.4% in 2011-2030 and a further decline to 1.8% in 2031-2050, influenced by an ageing population. The old-age dependency ratio is projected to rise from 26% in 2004 to 41% in 2050, albeit a smaller rise than on average in the EU.
The projected increase in age-related spending is below the average in the EU; rising by 1.3% points of GDP between 2004 and 2050.[144] However, public expenditure on pensions is projected to slightly fall in Sweden, to a large extent explained by the comprehensive pension reform enacted in 1998, when a notional defined contribution scheme was put into place, consisting of a notional defined contribution PAYG scheme (main part) and a private funded defined contribution scheme.[145] The latter will be classified outside government from 2007 onwards. The increase in expenditure on health-care is projected to be 1% point of GDP, lower than on average in the EU while for long-term care an increase of 1.7% points of GDP is projected, second-highest in the EU, influenced by Sweden spending the most in the EU on long-term care at present (3.8% of GDP in 2004).
In the calculations, the Swedish government finances (and the MTO of 2% of GDP) are reduced by the revenue-reducing impact of Eurostat's decision on the classification of funded defined contribution pension schemes that will take effect from 2007 onwards. The MTO is also technically adjusted downwards, to 1% of GDP in the MTO scenario (see Chapter III for further information). The figures with this adjustment are given in brackets in this part.
Swedish public finances have been sound in the recent past; with the government finances close to balance or in surplus since 1998. In 2005 a surplus of 2.9% (1.9%) of GDP was noted, considerably better than the 1.6% (0.6%) of GDP expected in the 2005 convergence programme (partially explained by one-off tax receipts). As a result of the strong fiscal position in recent years, the gross debt/GDP ratio has been reduced by around 3.5% of GDP in four years to reach 50.3% of GDP in 2005; the limited decrease in the debt ratio is explained by the accumulation of assets in the public pension schemes. The Swedish 2005 convergence programme projects broadly unchanged public finances over the medium-term and aims for a surplus of 1.7% (0.7%) of GDP in 2008. The MTO set in the stability programme at 2% (1%) of GDP is, with the better than expected fiscal outturn in 2005, already more than attained. According to the Commission services 2006 spring forecast a surplus of 2.3% (1.3%) of GDP is expected in 2007 on the basis of the current policies, above the programme's forecast of 1.2% (0.2%), suggesting that budgetary outcomes could be better than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, Sweden does not have a sustainability gap (S2 is -1.1% of GDP) in the baseline scenario. The long-term budgetary impact of ageing is lower than on average in the EU, due to the limited change in pension expenditure as a share of GDP influenced by the comprehensive pension reform enacted.
The initial strong budgetary position with a structural primary balance of 4.2% (3.2%) of GDP in 2005 contributes to the reduction of gross debt and the accumulating assets in pension schemes. Assuming that the MTO of a surplus of 2% (1%) of GDP is reached in 2010, the structural primary balance deteriorates; falling from 3.2% in 2005 to 2.4% of GDP in 2010 (including the cost of the reclassification of the pension scheme). The lower structural primary balance in 2010 would have a negative impact on the sustainability indicator; however, a sustainability gap does not emerge in the MTO scenario either (S2 is -0.3% of GDP).
The benefit ratio in Sweden is projected to decrease relatively markedly, by almost 25% in the period to 2050.[146] This is explained in part by the fact that the projections assume no change in the retirement age in the future compared with today. However, if people choose to work longer in the future (with the pension reform, it is possible to retire later than at 65), they can increase their pension rights and therefore limit the decrease in the benefit ratio in the future (by extending the working life by 2/3 of the increase in life expectancy by 2050, the replacement rate of an individual would remain unchanged).
According to Swedish long-term projections, taxes on pensions are projected to increase over the long-term by 0.7% of GDP between 2010 and 2050. However, general government property income in Sweden amounted to 2.3% of GDP in 2005, which is higher than on average in the EU. As shown in Chapter IV, risks to public finance sustainability might be underestimated by around half of this amount, by around 1% of GDP. These additional projections suggest that the long-term budgetary trends would be largely unchanged. However, a higher increase in expenditure on long-term care by about 1% point of GDP is projected by the Swedish authorities compared with the common projections, due to an assumption of higher wage growth in the long-term care sector compared with the rest of the economy, suggesting that the budgetary cost of ageing could be higher. Overall, these additional projections do not significantly alter the outlook for the long-term sustainability of the Swedish public finances.
Finally, Sweden has the highest level of taxation in the EU, suggesting that there is more limited room of manoeuvre to adjust the budget on the revenue side compared with other countries.
Overall assessment
The long-term budgetary impact of ageing in Sweden is lower than the EU average, with pension expenditure projected to remain relatively stable as a share of GDP over the long-term, influenced by the considerable expenditure-reducing impact of the reform of the pension system.
The initial budgetary position with a high primary surplus contributes to the reduction of gross debt and the accumulation of assets in pension schemes. Maintaining sound government finances with continued surpluses as planned would be key in view of limiting risks to the sustainability of public finances.
Overall, Sweden appears to be at low risk with regard to the sustainability of public finances.
[pic] 
 The United Kingdom 
 Long-term budgetary projections, recent budgetary developments and medium-term prospects
According to the recently published 'Ageing Report', the UK economy is projected to experience a slowdown of economic growth over the coming decades, from 2.8% during 2004-2010 to 2.1% in 2011-2030 and a further decline to 1.5% in 2031-2050, influenced by an ageing population.[147] The old-age dependency ratio is projected to rise from 24% in 2004 to 45% in 2050, albeit a smaller rise than on average in the EU.
The projected increase in age-related spending in the UK is somewhat higher than on average in the EU; rising by 4% points of GDP between 2004 and 2050. The increase in expenditure on public pensions in the UK is relatively limited, rising by 2% points of GDP. This reflects that the UK historically relies relatively more on private pension arrangements (occupational and individual schemes) than most other EU Member States. The increase in expenditure on health-care is projected to be 1.9% points of GDP, slightly higher than on average in the EU, influenced by relatively high expenditure on health-care at present compared to the average in the EU and on long-term care an increase of 0.8% points of GDP is projected, close to the average in the EU.
The UK has been placed in excessive deficit procedure and the European Council has recommended that the UK brings the deficit below 3% of GDP by the financial year 2006/07 at the latest. In 2005, the deficit was 3.5% of GDP (3.2% for the financial year 2005/06), after having been above 3% since 2003. As a result of the weak fiscal position in recent years, the debt/GDP ratio has risen by around 5% of GDP in three years, to 42.8% of GDP in 2005 (42% for the financial year 2005/06), although below the EU average. The UK 2005 convergence programme projects a gradual strengthening of the public finances over the medium-term, aiming at reducing the deficit to 1.5% of GDP in 20010/11. The programme does not specify a MTO. According to the Commission services 2006 spring forecast a deficit of 2.7% of GDP is expected in 2007/08 on the basis of the current policies, below the programme's forecast of 2.4% in 2007/08, suggesting that budgetary outcomes could be worse than projected in the programme.
Main findings and results
On the basis of the current budgetary position and the projected budgetary changes over the long-term, the UK has a sustainability gap of 4.9% of GDP in the baseline scenario. The long-term budgetary impact of ageing is close to the average in the EU.
The initial budgetary position with a structural primary balance of -1.1% of GDP in 2005 is insufficient to prevent unsustainable public finances even before considering the long-term budgetary impact of ageing. Assuming that a structural balance of -1% of GDP is reached in 2010, the structural primary balance improves; rising from -1.1% in 2005 to 1.1% of GDP in 2010. The higher structural primary balance in 2010 would have a positive impact on the sustainability gap; however, the gap would still be 2.7% of GDP in this scenario.
The benefit ratio in the UK is projected to decrease relatively markedly, by about 20% in the period to 2050. The UK relies traditionally on private pension arrangements, while provision of State pension remains at relatively low levels. The report of the Pensions Commission, a Government-appointed body tasked with reviewing provision of public and state pensions, has identified a clear risk that " the current system of private funded pensions combined with the current state system will deliver increasing inadequate results ", mainly as a consequence of a decreasing trend in private sector employer pension contributions since the early 1980s, which has not been matched by adequate personal savings.[148] The closure of more generous defined benefits schemes in favour of defined contributions ones, as well as the presence of the trend towards expanding means testing in state pension provision could exacerbate this risk in the future. Therefore, higher age-related expenditures over the present baseline could not be excluded as there are signs of insufficient provision of private pensions, linked to rising demographic costs that are leading to the closure particularly of the most generous occupational schemes. This might have implications for the public finances through greater enrolment in contributory state schemes and in greater recourse to means-tested pension and other benefits.
However, there have been significant developments in pension policy in the UK. The Pensions Commission made a number of proposals on how the pension system could be reformed (the "Turner report").[149] The government has endorsed most of its conclusions and proposals in its White paper " Security in retirement: towards a new pensions system ".
The White Paper's main measures include: a) a reform of private pension provision, by creating individual accounts into which most employers would be automatically enrolled, funded by a combination of Exchequer, employee and employer contributions; b) a reform of state pension provision, which on the one hand would be simplified moving towards a flat rate system, and on the other hand, would become more generous, as state pension would grow in line with earnings rather than prices as currently.[150] The costs of the latter reform would be partly offset by an increase in state pension age in line with longevity (an increase to 66 years by 2024, to 68 by 2046).
Thus the UK authorities' project that public pension expenditure would increase by an additional ½% point of GDP by 2050 with the implementation of the reform package.[151] The proposal, if successfully implemented, appeared to be posed to tackle the problem of inadequate savings, thus mitigating the risks discussed above, at a relatively affordable cost. However, making room for the projected increase in pension expenditure will require early fiscal action, given the current fiscal position and the desirability to smooth any fiscal adjustment over time.
According to the UK's long-term projections, tax revenues are projected to increase by some 2% of GDP between 2010 and 2050 as a result of the demographic change, notably assuming that more pensioners in the future will lead to higher tax revenues (directly through income tax and indirectly through indirect taxes). However, given the projected reduction in the public benefit ratio of some 20% up to 2050, this suggests that private pensions will increase over the long-term so as to compensate for the reduction. This would imply an increase in contributions private pension, which could in turn reduce tax revenues in the medium-term. Given the lack of projections on the future evolution of private pension provision (and contributions), it is not possible to assess the overall impact of changes in tax revenues over the long-term.
Overall assessment
The long-term budgetary impact of ageing in the UK is close to the EU average; with pension expenditure showing a somewhat more limited increase compared with the average in the EU, influenced in part by the UK historically relying relatively more on private pension arrangements. However, current pension arrangements might come under pressure at some point if the projected decrease in the benefit ratio was to fully materialise and risks to the public finances in the future can not be excluded. Moreover, the current proposed reforms, while addressing the risk of inadequate provision, could imply an (albeit modest) increase in expenditure compared to the pension projections used in this report.
The initial budgetary position is not sufficient to prevent the risk of unsustainable public finances even before considering the long-term budgetary impact of an ageing population. Consolidating the public finances would therefore be key in view of reducing risks to the sustainability of public finances.
Overall, the UK appears to be at medium risk with regard to the sustainability of public finances.
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 Chapter VII
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Glossary
Annuity A regular (e.g. monthly) income receivable established by public pension authorities or offered by insurance companies for a specified period or from retirement till death.
Budget balance The balance between total public expenditure and revenue (according to ESA95 ); with a positive balance indicating a surplus and a negative balance indicating a deficit. Also known as government net borrowing . For the monitoring of Member States' budgetary positions, the EU uses general government aggregates. See also cyclically-adjusted balance , primary balance, structural balance and reference values .
Budget constraint A basic condition applying to the public finances, according to which total public expenditure in any one year must be financed by taxation, borrowing or changes in the monetary base; the latter is prohibited in the EU. See also stock-flow adjustment and long-term sustainability .
Code of conduct Policy document adopted by the Economic and Financial Committee and endorsed by the Council of Ministers responsible for Economic and Financial Affairs (ECOFIN) in October 2005, containing specifications on the implementation of the Stability and Growth Pact and guidelines on the format and content of stability programmes and convergence programmes .
Contingent liabilities A possible government obligation to pay the existence of which will be confirmed by the occurrence of one or more uncertain events in the future not wholly under the control of government. For instance, government guarantees on debt issued by private or public companies are contingent liabilities, since the government obligation to pay depends on the non-ability of the original debtor to honour its obligations. See also implicit liabilities .
Convergence programme Medium-term budgetary and monetary strategy presented by each Member State that has not yet adopted the euro; updated annually, according to the provisions of the Stability and Growth Pact . See also stability programme, code of conduct and medium-term objective .
Cyclical component The transient part of the budget balance that reflects the public revenue and expenditure linked to the output gap. See automatic stabilisers , budgetary sensitivity , cyclically-adjusted balance and structural balance .
Cyclically-adjusted balance The budget balance adjusted for its cyclical component , i.e. the budget balance that would prevail if GDP were at its potential level. See also structural balance and output gap .
Cyclically-adjusted primary balance The cyclically-adjusted balance net of interest expenditure on general government debt. See also interest burden .
Debt dynamics The evolution of government debt as a ratio to GDP; it depends on the primary deficit , the debt-increasing impact of interest payments, the dampening effect of GDP growth on the ratio and the stock-flow adjustment .
Defined contribution pension scheme Pension scheme in which the plan sponsor pays fixed contributions and has no legal or constructive obligation to pay further contributions to an ongoing plan in the event of an unfavourable plan experience. Pension plan benefits are determined by such factors as contribution rates and returns on the plan’s investments. See also defined benefit pension scheme , funded pension scheme and pay-as-you-go pension scheme .
Defined benefit pension scheme Pension plan in which the sponsor company faces a legal or constructive obligation to pay further contributions to an ongoing plan in the event of an unfavourable plan experience. Benefits are usually determined by such factors as salary history and duration of employment. See also defined contribution pension scheme, funded pension scheme and pay-as-you-go pension scheme .
Dependency ratio A measure of the ratio of people who receive government transfers, especially pensions, relative to those who are available to provide the revenue to pay for those transfers. See also old-age dependency ratio .
Direct taxes Taxes that are levied on personal or corporate incomes and property. See also indirect taxation .
ESA95 European accounting standards for the compilation and reporting of macroeconomic (including budgetary) data by the EU Member States. See also Eurostat .
Eurostat The Commission department in charge of EU statistics. It is particularly responsible to check the quality of budget balance and government debt data notified by Member States. The quality check includes checking compliance with the ESA95 accounting rules, completeness, reliability, timeliness and consistency of the data. See also ESA95.
Excessive Deficit Procedure (EDP) A procedure according to which the Commission and the Council monitor the development of national budget balances and public debt in order to assess the risk of an excessive deficit in each Member State. Its application has been further clarified in the Stability and Growth Pact . See also s tability programmes and Stability and Growth Pact .
Expected return Gain from holding a financial claim net of expected loss from default risk, etc.
Funded pension scheme Pension system in which current pension expenditures are financed by running down assets accumulated over the years on the basis of contributions by the scheme beneficiaries. According to ESA95 , defined-contribution funded pension schemes are not considered as part of the general government sector. See also defined benefit pension scheme , defined contribution pension scheme and pay-as-you-go pension scheme .
General government The focus of EU budgetary surveillance under the Stability and Growth Pact and the excessive deficit procedure is on general government aggregates, with the general government sector covering national, regional and local government, as well as social security. In principle, public enterprises are excluded.
Government debt See public debt .
Implicit liabilities Future government expenditure which have not yet been funded, even when future expenditure is not backed by law or contractual obligations, but is simply grounded in strong expectations of the public. To be meaningful for economic analysis, implicit liabilities should be assessed net of future revenue assuming that the government will keep collecting taxes (and other non-tax revenue) at rates comparable to current levels. See also contingent liabilities .
Indirect taxation Taxes that are levied during the production stage rather than on the income and property arising from economic production processes (which are called direct taxes ). Prominent examples of indirect taxation are value added tax (VAT), excise duties, import levies, energy and other environmental taxes.
Indexation of benefits A revaluation of benefits, most often in line with prices and/or wages.
Interest burden General government interest expenditure on government debt as a share of GDP.
Intertemporal budget constraint It imposes that current total liabilities of the government, i.e. the current public debt and the discounted value of future expenditure, should be covered by the discounted value of future government revenue. See also long-term sustainability.
Lisbon strategy Partnership between the EU and Member States for growth and more and better jobs. Originally approved in 2000, the Lisbon Strategy was revamped in 2005. Based on the Integrated Guidelines (merger of the broad economic policy guidelines and the employment guidelines, dealing with macro-economic, micro-economic and employment issues) for the period 2005-2008, Member States drew up 3-year national reform programmes at the end of 2005. They reported on the implementation of the national reform programmes for the first time in autumn 2006. The Commission analyses and summarises these reports in an EU Annual Progress Report each year, in time for the Spring European Council.
Maturity structure of public debt The profile of debt in terms of when it is due to be paid back. Interest rate changes affect the budget balance directly to the extent that the general government sector has debt with a relatively short maturity structure. Long maturities reduce the sensitivity of the budget balance to changes in the prevailing interest rate. See also public debt .
Mature pension fund A pension fund with a long-term equilibrium ratio of workers to pensioners.
Medium-term objective (MTO) According to the Stability and Growth Pact , stability programmes and convergence programmes presents a medium-term objective for the budgetary position. It is country-specific to take into account the diversity of economic and budgetary positions and developments as well as of fiscal risk to the sustainability of public finances, and is defined in structural terms (see structural balance ).
Occupational pension scheme A pension plan whose access is linked to an employment or professional relationship between the plan member and the entity that establishes the plan (the plan sponsor). Occupational pension plans may be established by employers or groups thereof (e.g. industry associations) and labour or professional associations, jointly or separately.
Old age dependency ratio Population aged over 65 as a percentage of working age population (usually defined as persons aged between 15 and 64). See also dependency ratio .
One-off and temporary measures Government transactions having a transitory budgetary effect that does not lead to a sustained change in the budgetary position. See also structural balance .
Output gap The difference between actual GDP and potential GDP in any given year, usually expressed as a percent of potential GDP . Potential GDP is an unobserved variable and needs to be estimated from actual data. See also cyclical component and production function method .
Pay-as-you-go pension scheme (PAYG) Pension system in which current pension expenditures are financed by the contributions of current employees. Also known as unfunded pension scheme . See also funded pension scheme, defined benefit pension scheme and defined contribution pension scheme .
Pension fund A legal entity set up to accumulate, manage and administer pension assets. See also private pension scheme .
Potential GDP The level of real GDP in a given year that is consistent with a stable rate of inflation. If actual output rises above its potential level, then constraints on capacity begin to bind and inflationary pressures build; if output falls below potential, then resources are lying idle and inflationary pressures abate. See also production function method and output gap .
Primary balance The budget balance net of interest expenditure on general government debt. See also interest burden .
Private pension scheme Pension plan where a private entity receives pension contributions and administers the payment of pension benefits.
Production function method A method to estimate potential GDP typically based on a Cobb-Douglas production function. Potential GDP is estimated as the level of GDP consistent with a full utilisation of capital, an unemployment rate that does not accelerate inflation and factor productivity at its trend level. See also output gap, cyclical budget component, cyclically-adjusted balance .
Pension benefit Benefit paid to a participant (beneficiary) in a pension plan.
Pension contribution Payment made to a pension plan by the sponsor company or by scheme participants.
Property income property income received by the general government consists mainly of the revenues that the government receives from owning financial assets (including rents on land and sub-soil assets).
Public debt (or government debt) Consolidated gross debt for the general government sector. It includes the total nominal value of all debt owed by government units, except that part of the debt which is owed to government units in the same Member State. It is a gross debt measure meaning that government financial assets on other sectors are not netted out. See also debt dynamics and reference values .
Public investment The component of total public expenditure which consists in the acquisition of durable assets and through which governments increase and improve the stock of capital employed in the production of the goods and services they provide. Also known as government gross fixed capital formation (GFCF).
Public-private partnerships (PPP) Agreements between government and corporations according to which the latter build and operate public-use infrastructure (roads, tunnels, bridges, but also hospitals, prisons, concert halls, etc.) which were traditionally directly controlled by government. In exploiting the infrastructure, the corporation receives prices paid by final users, rentals or fees from the government or both. Infrastructure built under PPPs is considered as either government investment or corporate investment depending on a number of specific criteria.
Replacement ratio The ratio of pension to earnings at the point of retirement.
Sensitivity analysis An econometric or statistical simulation designed to test the robustness of an estimated economic relationship or projection to changes in the underlying assumptions.
‘Snow-ball’ effect The self-reinforcing effect of public debt accumulation or decumulation arising from a positive or negative differential between the implicit interest rate on public debt and the GDP growth rate. See also debt dynamics .
Social contributions Payments by employers and employees to a social insurance scheme to cover for pension, health care and other welfare provisions.
Stability and Growth Pact (SGP) Approved in 1997 and reformed in 2005, the SGP clarifies the provisions on budgetary surveillance in the EC Treaty. The “preventive” arm of the SGP obliges Member States to submit annual stability and convergence programmes , while the “corrective” arm of the SGP clarifies and speeds up the excessive deficit procedure .
Stability programme Medium-term budgetary strategy presented by each Member State that has already adopted the euro; updated annually, according to the provisions of the Stability and Growth Pact . See also convergence programme, code of conduct and medium-term objective .
Stock-flow adjustment (SFA) The stock-flow adjustment (also known as the debt-deficit adjustment) ensures consistency between government net borrowing , which is a flow variable, and the variation in government debt , which is a stock variable. It includes differences between cash and accrual accounting, accumulation of financial assets, changes in the value of debt denominated in foreign currency and remaining statistical adjustments. See also debt dynamics.
Structural balance The budget balance adjusted for its cyclical component and excluding one-off and temporary measures . See also fiscal stance .
Structural primary balance The structural balance net of interest expenditure on general government debt. See also interest burden .
Tax elasticity A parameter measuring the relative change in tax revenues with respect to a relative change in GDP. The tax elasticity is an input to the budgetary sensitivity .
Tax gaps Measure used in the assessment of the sustainability of public finances. They measure the difference between the current tax ratio and the constant tax ratio over a given projection period to achieve a predetermined level of debt at the end of that projection periodor to fulfil the intertemporal budget constraint
ANNEX I: Deriving the sustainability indicators
0. Legend
1. Deriving the S1 and S2 indicator under the assumption of constant growth rate/interest rate differential
2. Deriving the S1 and S2 indicator under the assumption of time-varying growth rat/interest rate differential
3. Deriving the cost of a delay indicator
4. Deriving the equivalence between sustainability indicators and implicit liabilities
5. Mathematic sensitivity of the indicators to the different inputs
0. Legend
[pic]is the index for the year
[pic]the last year before the long-term projection
[pic] (adjusted) gross debt relative to GDP
[pic]structural primary balance relative to GDP
[pic]change in structural primary balance compared to the base year [pic] relative to GDP
[pic]differential between the nominal interest rate and the nominal GDP growth rate i.e. [pic] where R and G are respectively the nominal interest rate (or discount rate) and the nominal growth rate
1. Deriving the S1 and S2 indicator under the assumption of constant growth rate/interest rate differential[152]
i. The inter-temporal budget constraint and the S2 indicator
There is no agreed definition on what constitutes a sustainable position for the public finances. One can however impose that the debt (relative to GDP) remains bounded at any time in the future so that it does not follow an explosive path. This implies (see proof in appendix) that the discounted value of future structural primary balances should cover the current level of debt, i.e.:
[pic] (1)
This condition is referred to as the inter-temporal budget constraint or the solvency condition. Given an initial debt, an interest-growth differential assumption and a future path of the structural primary balance, condition (1) may not be fulfilled. The S2 indicator is thus the change in the structural primary balance for every future year that ensures that condition (1) is true.
[pic] (2)
S2 is a sum of two different terms. The first term (D) is a condition concerning the initial budgetary position: if the structural primary balance (relative to GDP) remains unchanged in the future, the intertemporal budget constraint condition simply says that the structural primary balance should be equal to "apparent real" interest paid on the current level of debt. In that case, the level of debt would remain stable as a GDP. Indeed, debt relative to GDP increases by the difference between nominal interest rate and the nominal growth rate. If the structural primary balance compensates for this increase, the debt relative to GDP will remain stable. (D) is the distance between current structural budgetary primary balance and the debt-stabilizing primary balance .
The second term (E) is a condition concerning future developments in the structural primary balance: the bigger the decrease of the structural primary balance, the higher the immediate raise in the structural primary balance should be to fully compensate those changes. (E) is a synthetic measure of the time-varying future changes in the primary balance expressed as a constant change in the primary balance as a share of GDP.
ii. The S1 indicator
The S1 indicator is the change in the structural primary balance for every future year that is required to reach a debt ratio in 2050 of 60% of GDP. The calculations below are valid for any date T in the future and for any level of debt [pic].
[pic] (3)
As for S2, the S1 indicator is a sum of several terms. The first term (A) is the same as in S2. Contrary to S2, S1 also assumes that debt reaches a certain level of debt; the first term only ensures that debt as a share of GDP will remain at its starting level at a certain point in time. Additional effort measured by the second term (B) is therefore necessary to ensure that the debt will reach 60% of GDP in 2050. It tends to be large if the desired level of debt is small, the period of time given to reach this debt level is short or the initial debt is large. For countries with a lower initial level of debt, the term (B) is negative and reduces the sustainability gap.
The last term (C) is a condition concerning future developments of the structural primary balance. It is slightly different from the term (E) in the S2 indicator because S1 only takes into account changes in the structural primary balance up to 2050, which in most cases, underestimates the cost of ageing.
iii. Comparison of S1 and S2
The two indicators are in fact very close and the S1 indicator can be seen as a finite version of the intertemporal budget constraint. Indeed, if the debt requirement is set at a very distant date in the future, the two indicators S1 and S2 will be very close.
Given that [pic] ; [pic] ; [pic]
[pic] (4)
In practice, given the not so distant requirement (2050) and the low differential between interest and growth rates, S1 and S2 are different.
Table A.1.1 sums up the calculations of S1 and S2.
Table A.1.1. Comparison of S1 and S2
Current budgetary position | Debt requirement in 2050 | Long-term changes in the primary balance |
S1= | A=[pic] | + | B=[pic] | + | C=[pic] |
S2= | D=[pic] | + | 0 | + | E=[pic] [pic] (5) |
Two different reasons may lead S1 to be greater than S2:
- The debt requirement will increase S1 if the initial level of debt is above 60% and decrease S1 otherwise: nothing similar is imposed in the calculations of S2. Therefore high-debt countries, i.e. countries whose debt is above 60% in 2005 or at the end of the programme period, may have a higher S1 than S2. For instance, the debt requirement will increase S1 by around ¾% point of GDP, for a country with an initial adjusted gross debt level of 100%[153].
- The other difference between the two indicators comes from the horizon over which future changes in the primary balance are taken into account: over the period up to 2050 in the case of S1 and over infinite horizon in the case of S2. In EU countries, the overall budgetary impact of ageing is usually increasing over the next decades so that the maximum budgetary impact happens towards the end of the period. In that case, the change in the primary balance is higher in 2050 than it is on average over the period 2010-2050: the impact of changes in primary balances is then larger in S2 than in S1[154]. However, some countries have enacted a large pension reform that is progressively implemented so that the increase in public expenditure reaches its maximum in the middle of the period before being significantly reduced afterwards. Those countries may exhibit a higher S1 than S2
To sum up, S2 should be in most cases greater than S1 except for countries where the initial level of debt is substantially higher than 60% and/or the increase in expenditure due to ageing is lower in 2050 than on average over the period up to 2050 .
iv. The required primary balance
Instead of presenting public finance imbalances as a gap towards a sustainable situation, it is also possible to present the resulting target in terms of primary balance (the required primary balance) that would result from a budgetary consolidation in the medium-term that ensures sustainability. The required primary balance can be calculated for both indicators (though the Commission regularly calculates the required primary balance for the S2 indicator).
[pic] (6)
Formula (6) shows that the RPB is a more stable indicator than the sustainability indicator. Indeed, it only depends on the current level of debt, the projected budgetary change over the long-term and the interest rate/growth rate differential. These data typically change infrequently, e.g. if a pension reform is implemented or if the future outlook on demography, potential growth or interest rate are changed. By contrast, sustainability gap are also sensitive to changes in the current structural primary balance, which are more common.
2. Deriving the S1 and S2 indicator under the assumption of time-varying growth rat/interest rate differential
The interest-growth rate differential has so far been assumed constant. This is not the case in the current EU framework to assess public finance sustainability. The real interest rate is constant for all EU25 countries and equal to 3% while GDP growth projections are country-specific.
Lets introduce [pic] if [pic]and 1 otherwise.
The dynamics of debt is: [pic];
The inter-temporal budgetary constraint is: [pic]
The S2 indicator is: [pic](2bis)
In the case where the interest rate/growth rate differential and the structural primary balance are constant after a certain date (here 2050):
[pic] (2ter)
S1 is such that [pic]
[pic] (3bis)
Box A.1.2. Proofs
Equation 1
Let’s suppose the debt (relative to GDP) remains bounded at any time in the future.
It means that [pic]such as [pic]
So [pic] because r is strictly positive.
[pic] (1)
Equation 2
The S2 indicator is the change in the structural primary balance compared with the base year for every future year that ensures that condition (1) is fulfilled.
Mathematically, it can be written:[pic] (1).
Since the discount rate is strictly positive,[pic].
[pic]
[pic] (2).
Equation 3
The calculations are made for any date T in the future and for any target level of debt in the future. The dynamics of the debt can be written:
[pic]
[pic]is such that [pic]
[pic]
Given [pic]
[pic]
[pic]
[pic] (3)
Equation 5
[pic]
3. Deriving the cost of a delay indicator
It provides an estimate of the cost of delay in making a complete adjustment according to the old S1 and the S2 indicators. It further assumed a constant interest rate-growth rate differential. The cost of a delay with non-constant interest rate for the currently used indicators, S1 and S2, are given here.
S1 indicator:
The expression for the cost of delay using the S1 indicator is:
[pic]
S2 indicator:
If the adjustment is made today, [pic]
If the adjustment is postponed in 5 years then, [pic]
Relationships between the two indicators:
[pic]
The cost of the delay is proportional to the initial tax gap indicator. If r is constant, the former formula is significantly reduced:[pic]
4. Deriving the equivalence between sustainability indicators – a 'flow' measure - and implicit liabilities/debt – a 'stock' measure
Chapter I.3.2 showed that the sustainability indicators can also be expressed as the stock of net implicit liabilities, or, net implicit debt under certain assumptions. In particular, if for both the sustainability gap measure and the net implicit debt measure it is assumed that they: (i) have the same starting point, i.e. the structural primary balance of general government; (ii) have the same discount rate; (iii) they have the same coverage of future government commitments (i.e. age-related expenditures evolving in line with demographic developments); and, (iv) they take into account that government's ability to receive the same revenues as a share of GDP as today, the S2 sustainability indicator less the current level of debt can be expressed as the current stock of net implicit debt. Specifically, one can define the net implicit liabilities of the general government, [pic], as the discounted future structural primary balances, or equivalently the net present value of future primary deficits: [pic]=[pic] i.e. the net present value of non-financed future public spending.
In this case, the S2 can be rewritten as
[pic]
One can express the level of implicit debt as a function of S2 and current level of debt, showing that those two measures are indeed equivalent.
[pic]
This definition of net implicit debt covers all future imbalances linked to age-related social spending on pensions, health-care, long-term care, education and unemployment. It is however not limited to those five expenditure items. The starting point is defined for the total general government sector, which also includes other items. If the current structural primary balance is lower than the debt-stabilizing structural primary balance, it is also included in this definition of the implicit debt. By contrast, if the current structural primary balance is larger than the debt-stabilizing primary balance, it means that the general government is in the process of accumulating assets and/or reducing debt.
In the calculation of S2 sustainability gap, explicit debt and net implicit debt are given equal importance. It should be borne in mind that the value of net implicit debt depends on the long-term projections and strongly on the discount rate. It is therefore not as "observable" as the current level of debt is.
It should be noted that implicit debt is even more sensitive to the interest rate than the sustainability indicator. Indeed, sustainability indicators are bounded, because the impact ageing reaches a maximum (at the latest in 2050, after which the primary deficit is kept constant). The intuition behind the result is straightforward. If a country is expected to experience a maximum increase of 5% of GDP of public spending, current adjustment to cover this increase is necessary less than 5%, as the interest rate/growth rate differential is positive. In general, the lower the interest rate, the higher the overall increase will be. By contrast, implicit debt is not bounded. In the extreme where the interest rate is very close to the growth rate (or equivalently r is close to zero), the implicit debt can be very large. Changing the assumptions for the interest rate can therefore give rise to a larger variation in the 'stock' measure (implicit debt) measure compared with the 'flow' measure (sustainability indicators).
ANNEX II: Sensitivity tests
1. Hypotheses on demographic and economic assumptions 

Table A.2.1. Budgetary items affected by changes in assumptions
Pensions | Health-care | Long-term care | Unemployment benefits | Education |
Higher life expectancy | AR | AR | AR | =0 | =0 |
Higher employment | AR | ~0 | ~0 | Projection made with the same methodology as in the Ageing Report | Projection made with the same methodology as in the Ageing Report |
Higher employment of older workers | AR | ~0 | ~0 | =0 | Projection made with the same methodology as in the Ageing Report |
Higher labour productivity | AR | ~0 | =0 | =0 | =0 |
Higher interest rate | AR | =0 | =0 | =0 | =0 |
The sensitivity tests are run on the total public expenditure. Non-age related expenditure and public revenue are supposed to be unchanged as a share of GDP in all alternative scenarios as it is the case in the baseline scenario. Regarding age-related expenditure, sensitivity tests, available in the Ageing Report, have been used ("AR" in the Table A.2.1).
In the Ageing Report, not every sensitivity test has been run on every of the four age-related budgetary items other than pensions (health care, long-term care, unemployment benefits and education) because:
-  in many cases, the impact on expenditure as a share of GDP following the Ageing Report methodology is strictly nil ("=0" in Table A.2.1). This is straightforward for the impact on interest rates on health-care, long-term care, unemployment benefits and education. The change in labour productivity impacts directly GDP growth but impacts also accordingly GDP/worker growth on which long-term care, unemployment benefits and education are indexed. This leaves unchanged the ratio of those expenditure items to GDP. Finally higher life expectancy has no impact on unemployment benefits and education;
-  in other cases, the impact on expenditure as a share of GDP is theoretically non-zero but can be neglected in the calculations ("~0" in Table A.2.1). In the Ageing Report reference scenario, health-care is indexed on GDP/capita so, in that respect, its GDP share is not impacted by higher productivity and/or higher unemployment. However, there is an income elasticity for health-care in the reference scenario; therefore higher GDP growth should normally result in an increase in the GDP share of health-care but the effect is small;
-  the scenario of an increase in the employment rate is supposed to come from a decrease in the NAIRU (see Box A.2.1), which also reduces unemployment benefits as a share of GDP. This sensitivity test on unemployment benefits is not in the Ageing Report therefore an additional scenario has been run using the same methodology as in the Ageing Report with a lower NAIRU. However, it should be recalled that the reading of the results will depend on its use. To estimate the uncertainty surrounding the sustainability indicator regarding the level of the future employment rate (with an unchanged NAIRU), only the budgetary impact of the sensitivity test on pensions should be considered. To estimate the uncertainty surrounding the indicator regarding the level of the NAIRU (with unchanged participation rates), both the impact on pensions and on unemployment expenditure should be considered.
Box A.2.1. Description of the alternative hypotheses
-  Higher life expectancy scenario assumes an increase in life expectancy, which corresponds roughly to an increase in life expectancy at birth of 1-1.5 years by 2050. Specifically, it was introduced by decreasing the age-specific mortality rates by 15% linearly over the period 2004-2050.
-  Higher employment rate scenario assumes that the employment rate will increase by 1 p.p. over the period 2005-2015 and thereafter will remain at a 1 p.p. higher level in the period 2015-2050 compared with the baseline projection. The higher employment rate was assumed to be achieved by lowering the rate of structural unemployment (i.e. the NAIRU).
-  Higher employment rate of older workers scenario assumes that the employment rate of older workers will increase by 5 p.p. over 2005-2015 and thereafter will remain at a 5 p.p. higher level over the period 2015-2050, compared with the baseline projection. The higher employment rate is assumed to be achieved through a reduction in the inactive population.
-  Higher labour productivity scenarios assumes an increase in the labour productivity growth rate by 0.25 p.p. over 2005-2015 and thereafter remaining at the 0.25 p.p. higher/lower level in comparison with the labour productivity growth rate in the baseline projection.
-  Higher interest rate scenarios assume interest rates of 4% vs. 3% in the baseline scenario.

 The following points should be noted:
-  alternative scenarios on productivity and employment impact GDP growth. But if GDP growth changes compared with the baseline scenario, returns on assets will increase accordingly and so will interest rates. To keep the same real cost for the general government to finance its debt, the same interest/growth rate differential as in the baseline is used in the calculations of the sensitivity analysis. The impact of a higher interest rate/growth rate differential is analysed as a separate sensitivity test (namely higher interest rate);
-  the impact of life expectancy on health-care and long-term care expenditure was run on the so-called "pure-ageing" scenario. The Ageing Report reference scenario assumes that the health status improves by half as much as in the constant health scenario. Therefore the sensitivity test on health-care may slightly overestimate the impact of higher life expectancy compared to the baseline scenario.
2. Alternative scenarios for health-care
As shown in Table A.2.2., all alternative scenarios have been run using the pure ageing scenario as a baseline. In the main text the S2 indicators have been calculated as if the Ageing Report reference scenario was replaced by the alternative scenario.
Table A.2.3 show the change on the S2 indicator resulting from implementing one of the alternative scenarios instead of the 'pure ageing' scenario.

 Table A.2.2. Alternative scenarios of health care
Pure ageing | Constant health | Death-related costs | Income elasticity of demand | Unit costs –GDP per worker | Ageing Report reference scenario |
Age-related expenditure profile | Constant 2004 profiles over the projection period | 2004 profiles shift in line with changes in age-specific life expectancy | Constant 2004 profiles but split into spending on decedents and survivors | Constant 2004 profiles over the projection period | Constant 2004 profiles over the projection period | 2004 profiles shift by half the change in life expectancy |
Unit cost development | GDP per capita | GDP per capita | GDP per capita | GDP per capita | GDP per worker | GDP per capita |
Income elasticity of demand | 1 | 1 | 1 | 1.1 in base year converging to 1 by 2050 | 1 | 1.1 in base year converging to 1 by 2050 |
Table A.2.3. Impact on the sustainability indicator of alternative health-care assumptions (deviation from S2 in % points of GDP)
Constant health | Death-related costs | Income elasticity | Unit-costs GDP per worker | Ageing Report reference scenario |
BE | -0.7 | -0.4 | 0.3 | 0.2 | -0.1 |
CZ | -0.7 | -0.4 | 0.5 | 0.9 | 0.1 |
DK | -0.7 | -0.3 | 0.3 | 0.5 | -0.1 |
DE | -0.6 | -0.3 | 0.2 | 0.2 | -0.1 |
EE | -0.5 | -0.3 | 0.5 | -0.1 | 0.2 |
EL | -0.5 | -0.3 | 0.2 | 0.5 | 0.0 |
ES | -0.5 | -0.3 | 0.3 | 0.4 | 0.0 |
FR | -0.7 | -0.3 | 0.3 | 0.4 | 0.0 |
IE | -0.7 | -0.4 | 0.4 | 0.2 | 0.0 |
IT | -0.5 | -0.2 | 0.2 | 0.3 | 0.0 |
CY | -0.3 | -0.2 | 0.2 | 0.1 | 0.1 |
LV | -0.4 | -0.3 | 0.6 | -0.1 | 0.3 |
LT | -0.3 | -0.2 | 0.4 | -0.2 | 0.2 |
LU | -0.6 | -0.2 | 0.5 | -1.3 | 0.1 |
HU | -0.6 | -0.4 | 0.4 | 0.3 | 0.0 |
MT | -0.6 | -0.7 | 0.2 | 0.1 | -0.1 |
NL | -0.4 | -0.3 | 0.2 | 0.4 | 0.0 |
AT | -0.6 | -0.3 | 0.2 | 0.4 | -0.1 |
PL | -0.5 | -0.3 | 0.4 | -0.3 | 0.1 |
PT | -0.6 | -0.3 | 0.2 | 0.7 | -0.1 |
SI | -0.4 | -0.3 | 0.4 | 1.0 | 0.2 |
SK | -0.5 | -0.3 | 0.4 | 0.6 | 0.1 |
FI | -0.5 | -0.3 | 0.3 | 0.3 | 0.0 |
SE | -0.7 | -0.3 | 0.3 | 0.8 | 0.0 |
UK | -1.1 | -0.4 | 0.4 | -0.3 | -0.3 |
EU25 | -0.7 | -0.3 | 0.3 | 0.2 | -0.1 |
EU12 | -0.6 | -0.3 | 0.3 | 0.3 | -0.1 |
Standard deviation | 0.2 | 0.1 | 0.1 | 0.5 | 0.1 |

 ANNEX III: Council opinions on the 2005/06 Stability and Convergence Programmes
Table A.3 Policy conclusions by the Council on the sustainability of public finances based on the assessment of the 2005/06 updated stability and convergence programmes
Are public finances sustainable? | What are the main issues? |
BE | Belgium appears to be at medium risk on grounds of the projected budgetary costs of ageing populations and considering the need to sustain high primary surpluses for a prolonged period of time. | The current level of gross debt, while declining, remains well above the reference value and the steady reduction of the debt ratio foreseen in the update is necessary. The Belgian strategy of putting longer-term concerns at the heart of fiscal policy, including by reducing debt, will undoubtedly alleviate sustainability risks and the "ageing fund law" reinforces the political commitment by setting legally binding budgetary targets. Furthermore, recent measures aimed at increasing the effective retirement age and the employment ratio should contribute positively to sustainability. However, the current budgetary position may not be sufficient to cover fully the substantial increase in expenditure due to ageing populations, underlining the importance of maintaining large primary surpluses in the coming years. |
CZ | The Czech Republic appears to be at high risk on grounds of the projected budgetary costs of ageing populations. | While the debt ratio is currently relatively low in an EU perspective, the high deficit contributes to a rising debt ratio in the long-term projections until 2050, which increases the risk to debt sustainability. At the same time, the projected high increases of pension expenditure over the projection period are expected to put a significant burden on the public finances. A rigorous implementation of the planned consolidation of public finances over the medium term and a further strengthening of the budgetary position together with additional structural reforms to contain the increase in age-related expenditures, in particular on pensions and health care, appear to be of key importance in order to mitigate the risks to public finance sustainability. |
DK | Denmark appears to be at low risk on grounds of the projected budgetary costs of an ageing population, due to its solid public finances and provided that the assumed employment increases and low government consumption growth are achieved, which requires further labour market reforms and spending restraint. | The strategy of putting sustainability concerns at the heart of fiscal policy making, including containing pension expenditure and involving accumulation of assets, contributes positively to the long-term outlook for public finances. The currently favourable budgetary position contributes to the financing of the projected budgetary impact of an ageing population and the medium-term budgetary plans are consistent with sustainable public finances |
DE | Germany appears to be at medium risk on grounds of the projected budgetary costs of ageing populations. | The structural reforms carried out in previous years, and in particular the pension reform, have helped to contain future rises in public expenditure. In view of the current level of government gross debt exceeding the Treaty reference value of 60% of GDP and the currently high structural deficit, implementing rigorously a strong budgetary consolidation over the programme period is necessary so as to reduce the risks to long-term sustainability. |
EE | Estonia appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The level of gross debt is currently very low and is projected to remain below the 60% reference value throughout the projection period. Estonia’s strategy of putting sustainability concerns at the heart of fiscal policy making, including the pension system reform which involves the accumulation of assets, contributes positively to the outlook for the public finances. The current budgetary position in surplus contributes towards limiting the projected budgetary impact of an ageing population, and the medium-term budgetary plan of maintaining balanced budgets is consistent with low risks to public finance sustainability. |
EL | Greece appears to be at high risk on grounds of the projected budgetary costs of ageing populations. | The debt ratio is currently the highest in the EU, and is projected to remain at very high levels throughout the projection period up to 2050. It is therefore necessary to implement rigorously the planned consolidation of public finances over the medium-term and to further strengthen the budgetary position in order to reduce risks to public finance sustainability. At the same time, the projected increase of government expenditure, notably on pensions, over the projection period is expected to put a high burden on public finances. To this end, resolutely implementing measures enacted and designing and carrying out additional structural reforms, notably on pensions, are necessary so as to reduce the risks to public finance sustainability. |
ES | Spain appears to be at medium risk on grounds of the projected budgetary costs of ageing populations. | The currently favourable budgetary position, including the debt position and accumulation of assets in the Social Security Reserve Fund, contribute to absorb somewhat the projected increase of pension expenditures. However, the significant increase in these expenditures over the projection period suggests that the implementation of the measures within the announced social welfare reform aimed at containing the budgetary impact of ageing, notably concerning pensions, could be an important element in reducing risks to the sustainability of public finances. |
FR | France appears to be at medium risk on grounds of the projected budgetary costs of ageing populations. | Recent reforms, notably the 2003 pension reform, have substantially helped to contain future rise in public expenditure and their full implementation will be crucial to ensure the expected results. The current level of government gross debt is above the Treaty value of 60% of GDP, and the currently high structural deficit, if unchanged, will prevent the necessary reduction of debt in view of the future cost of ageing. Therefore, in the absence of additional reforms, strong budgetary consolidation is needed in order to reduce the risks to long-term sustainability. |
IE | Ireland appears to be at medium risk on grounds of the projected budgetary costs of an ageing population. | The currently sound budgetary position, in conjunction with the low debt level and the accumulation of assets in the National Pension Reserve Fund, helps partly to offset the significant rise in age-related government expenditure, notably on pensions, projected over the long term. Ireland has also recently enacted reforms to the pension system for public servants, and the authorities envisage further measures that should contribute to a more sustainable basis for the provision of public service pensions. The commitment to monitoring the adequacy of contribution rates through regular actuarial reviews is helpful. Implementing additional measures aimed at easing the budgetary impact of an ageing population over the long term would be nevertheless an important element in reducing risks to the sustainability of public finances. |
IT | Italy appears to be at medium risk on grounds of the projected budgetary costs of an ageing population. | Past reforms have helped to contain future rises in public expenditure and their full implementation, notably of the 2004 pension reform, will be crucial to obtain the expected results. The currently high level of gross debt and the weak budgetary position indicate the necessity for strong consolidation of public finances over the medium-term to reduce risks to public finance sustainability |
CY | Cyprus appears to be at high risk on grounds of the projected budgetary costs of ageing populations. | Implementing rigorously the planned consolidation of public finances over the medium term will alleviate the risks to long-term sustainability and, as recognized in the programme, substantial pension and health care reform measures will also be necessary to contain the projected high increase in age-related expenditure in the period up to 2050 and to reduce the risk to long-term sustainability. |
LV | Latvia appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The currently very low level of gross debt is projected to remain below the 60% reference value throughout the 2005-2050 projection period. Latvia is implementing a pension reform launched in 1996 which contributes significantly to contain the budgetary impact of ageing populations. |
LT | Lithuania appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The level of gross debt is currently very low and is projected to remain below the 60% of GDP reference value throughout most the projection period and a contained government deficit is planned over the programme period. Lithuania has enacted a pension reform which contributes significantly to contain the budgetary impact of ageing populations. Further changes to the pension system are envisaged by the Lithuanian authorities, aiming at increasing the replacement rates for pensioners and at the same time gradually raising the retirement age. The implementation of the latter measure would be key in ensuring the financial sustainability of the public pension system. |
LU | Luxembourg appears to be at medium risk on grounds of the projected budgetary costs of ageing populations. | The current level of debt is certainly very low and the planned consolidation over the medium term should contribute to partly alleviating the risk to public finance sustainability. However, Luxembourg has experienced, over the last two decades, a period of exceptionally strong employment growth which will progressively translate into a similar increase in the number of pensioners and into a large increase in pension expenditure. While it contributes significantly to public finance sustainability, the current size of pension fund assets will not be sufficient and, as recognised by the programme, some changes in the pension schemes will prove necessary at some point to contain future increase in public expenditure and reduce the risk to long-term sustainability. |
HU | Hungary appears to be at high risk on grounds of the projected budgetary costs of ageing populations. | The gross debt-to-GDP ratio is currently close to the reference value and is projected to increase in the period up to 2050. Hungary reformed its pension system in the late 1990s, aimed at contained future rises in expenditure on pensions, which helped to reduce the budgetary impact of ageing. However, increases in government expenditure on pensions could be higher than projected in the update, suggesting that a close monitoring of factors that are assumed to offset such higher expenditures as well as developments in pension and other age-related expenditures is important. Moreover, the currently high structural deficit contributes to increase sustainability risks. It is therefore necessary to carry out a large consolidation of public finances over the medium-term and to further strengthen the budgetary position in order to reduce risks to public finance sustainability. |
MT | Malta appears to be at medium risk on grounds of the projected budgetary costs of ageing populations. | The level of gross debt is currently above the 60% reference value and the currently high structural deficit, if unchanged, will prevent the necessary reduction of the gross debt ratio from falling below the Treaty reference value over the long term. Implementing rigorously the planned budgetary consolidation over the programme period would therefore contribute to reducing debt below the reference value, with positive consequences for risks to public finance sustainability. Changes to the pension system are envisaged by the Maltese authorities, aiming at ensuring adequacy and sustainability of the pension system. The implementation of the reform would be key in ensuring the financial sustainability of the public pension system. |
NL | The Netherlands appears to be at medium risk on grounds of the projected budgetary costs of ageing populations. | The current level of debt is under the Treaty value of 60% of GDP and the recent improvement of the budgetary situation in the Netherlands has helped alleviate risks to long-term sustainability. The implementation of recent reforms of the disability scheme will also contribute to curb long-term public spending. However, even fully taken into account, the projected future rise in revenue, notably due to delayed taxation of pension is not sufficient to compensate the rise in public expenditure over the long-term. Further budgetary consolidation may therefore be necessary to fully offset the impact of ageing. |
AT | Austria appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The level of debt, currently above 60% of GDP, is projected to fall and remain below the reference value up to 2050 on the assumption that the planned budgetary consolidation is implemented. Austria’s recent pension reform should contribute significantly to the containment of future increases in public expenditure. However, the structural deficit in the government finances, if not corrected, could pose a risk to public finance sustainability. Implementing the planned consolidation of public finances over the medium term is therefore instrumental for reducing the risks to public finance sustainability. |
PL | Poland appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The level of debt is currently under the 60% reference value and should remain so under the assumption that savings related to the implementation of the 1999 pension reform will materialise. The reform is ambitious and contributes to the solving of the ageing problem, but measures recently adopted by the government to exclude particular employment groups from the reformed pension scheme could weaken the reform’s long-term outcome, particularly if further exemptions from the pension schemes were granted. The realization of contingent liabilities as well as the currently high structural deficit may increase the debt/GDP ratio faster than planned over the medium term. Implementing rigorously the planned consolidation of public finances over the medium-term would reduce risks to long-term sustainability. |
PT | Portugal appears to be at high risk on grounds of the projected budgetary costs of ageing populations. | The currently high level of gross debt and the weak budgetary position indicate the necessity for implementing rigorously the planned consolidation of public finances over the medium-term and to ensure the attainment of the budgetary targets in order to reduce risks to public finance sustainability. However, the projected increases in pension and health care expenditures over the projection period clearly indicate the necessity of a comprehensive strategy in dealing with the challenge posed by ageing populations that goes beyond improving the currently weak budgetary position. The ongoing introduction of changes to the pension and healthcare systems should go some way in making these systems more sustainable. However, further reforms are required to curb the projected growth of age-related expenditures. |
SI | Slovenia appears to be at high risk on grounds of the projected budgetary costs of ageing populations. | The relatively low debt ratio will contribute to limit the budgetary impact of ageing. However, Slovenia will still face a very large increase in government expenditure. Even though the 1999 pension reform has significantly alleviated future increase in expenditure, its effects have been partly offset by the modification of the indexation rule. Further changes in the pension schemes, as recognised by the programme, will prove necessary at some point to contain future increase in government expenditure and reduce the risk to long-term sustainability. If no further measures are taken to relieve the pressures of age-related expenditure, the long-term sustainability of public finances will be undermined. A careful planning and timely adoption of measures are key in this regard. |
SK | With regard to the sustainability of public finances, Slovakia appears to be at low risk on grounds of the projected budgetary costs of ageing populations, subject to the sustained fiscal consolidation also beyond the programme period and the full implementation of enacted reforms, as well as other reforms of a structural nature (including a reduction of unemployment). | The level of debt is significantly under the 60% reference value and should remain so under the assumption of unchanged policies for the coming two decades. However, the continuation of the currently high structural deficit will prevent the reduction of the debt/GDP ratio, which increases the risk to long-term sustainability. Implementing rigorously the planned consolidation of public finances over the medium-term is necessary in order to reduce risks to long-term sustainability. |
FI | Finland appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The gross debt ratio is currently below the 60% of GDP reference value, and is projected to remain below this value throughout most of the projection period which extends until 2050. The significant assets of social security and the currently favourable budgetary position contribute to limit the budgetary impact of ageing populations. However, in the long run, a risk to public finance sustainability could emerge, reflecting rising pension expenditure. Containing age-related expenditure over the long term, including the successful implementation of recent reform measures aimed at rising the effective retirement age, while maintaining sound budgetary positions would be key components in reducing risks to public finance sustainability. |
SE | With regard to the sustainability of public finances, Sweden appears to be at low risk on grounds of the projected budgetary costs of ageing populations. | The level of gross debt is currently comfortably below the 60% reference value and is projected to remain below the reference value throughout most of the programme period. The Swedish strategy of putting sustainability concerns at the heart of fiscal policy making, including the pension system reform which contains pension expenditure and involves accumulation of assets, contributes positively to the outlook for the public finances. The currently favourable budgetary position contributes to limiting the projected budgetary impact of ageing populations while the planned consolidation towards the 2% MTO at the end of the programme period contributes to improve sustainability. |
UK | With regard to the sustainability of public finances, in combination with an increase in the cost of ageing, the possibility of insufficient provision of private pensions increasing fiscal costs would put the United Kingdom at medium risk, unless changes are made to improve fiscal sustainability. | Over the period until 2050, a contained rise in public pension expenditure is projected. However, higher age-related expenditure pressures cannot be excluded as there is a possibility of insufficient provision of private pensions. Pension policy is currently under review and the government’s response to the November 2005 Pensions Commission report is expected in spring this year. The currently favourable debt position contributes to limit somewhat the budgetary impact of ageing populations; however, gross debt is projected to go above the 60% of GDP reference value during the projection period to 2050 if, compared to the structural budgetary position in 2005/06, no further budgetary consolidation takes place during the programme period. Improving the structural balance of government finances over the medium term would contribute to reducing risks to public finance sustainability. |
Source: Council Opinions on the 2005/06 updated stability and convergence programmes on the basis of the Commission’s assessment
[1] See Economic Policy Committee and European Commission-DG ECFIN (2006) ‘The impact of ageing on public expenditure: projections for the EU25 Member States on pensions, health-care, long-term care, education and unemployment transfers (2004-2050)’, European Economy, Special Reports No 1, 2006, henceforth called the 'Ageing Report'.
[2] Commission's assessments of the updates of stability and convergence programmes can be found at the following address:
http://ec.europa.eu/economy_finance/about/activities/sgp/year/year20052006_en.htm
[3] Medium-term debt sustainability assessment underpins the IMF's decisions in the context of the Fund-supported programmes, in particular by helping to determine when financing is appropriate, what might be a sensible level of access, and whether a debt restructuring may be needed (see IMF, 2002, 2003a and 2003b).
[4] See e.g. Ageing and the Sustainability of Dutch Public Finances, CPB Netherlands, 2006; Long-term public finance report: an analysis of fiscal sustainability, HM Treasury, 2005; Fremtidens velfærd – vores valg, Velfærdskommissionen (Denmark), 2005; Langtidsutredningen 2003/04, SOU 2004:19 (Sweden), 2004; Rapport Annuel du Comité d'Etude sur le Viellissement en Belgique, 2006; IMF Article IV reviews.
[5] In fact, the intertemporal budget constraint only requires that the debt does not increase too fast; more precisely, that nominal debt does not increase faster than the nominal interest rate.
[6] Blanchard et al. (1990) uses as a target the initial level of debt as a share of GDP over a 40 years period. A former target of the EU was the initial nominal debt level (the T1 indicator, see for example Public finances in EMU, 2005, page 121). The UK uses a net debt target of 40% in 2100. This small sample shows the diversity of targets that can be envisaged.
[7] The notion of long-term debt-stabilizing primary balance refers to the primary balance that, if reached, would stabilize the debt in the long-run at its current level. It therefore depends on the long-term prospects of GDP growth and interest rates. It can differ from the short-term debt-stabilizing primary balance that can be calculated with current nominal GDP growth and nominal interest rates.
[8] The final projections are published in EPC and European Commission (2006) and the underlying assumptions in EPC and European Commission (2005).
[9] For the results of the 2001 exercise see Economic Policy Committee (2001).
[10] This assumption was complemented by adding the effect of income elasticity equal to 1.1 in the base year converging to unity in 2050.
[11] For example, by investing in educational services, governments can contribute to productivity and encourage job-creating investment. Moreover, investing in education would contribute positively to employment prospects, see the Commission's Communication 'Efficiency and equity in European education and training systems (2006).
[12] Defining current policies in a long-term perspective is not an easy task. Indeed, some public arrangements are designed for the very long run. This is typically the case for pensions and can be projected as such. However, other rules are not set in a long-term perspective: this is typically the case of nominal tax brackets for income tax. If they were to be kept constant in nominal or even in real terms in the long run, the entire population would eventually be subject to the maximum marginal tax rate: such a change in the redistributive feature of the tax system can hardly be considered as an 'unchanged policy' scenario. Other modelling choices are therefore more appropriate in a long term perspective; e.g. keeping the overall tax rate constant on household income. For a more detailed discussion see for example Ageing in the Netherlands 2006, CPB.
[13] The choice of the interest rate is discussed in 'Underlying assumptions and projection methodologies'; European Economy Special Report n°4/2005, pages 92-95. The impact of changing the assumption on the interest rate is shown in Chapter III.2.4.
[14] Hauner (2005) argues that other hypotheses for non age-related primary expenditure could be envisaged. For example, one could keep real expenditure constant or constant per capita. Those assumptions would drive down the risks to sustainability, albeit differently across countries.
Alternative assumptions for revenue developments are discussed in Chapter IV.3.
[15] The method for calculating the cyclically-adjusted balance is the commonly agreed method used in the assessment of the stability/convergence programmes (see Denis and al., 2006).
[16] The rationale underlying the decision is that the assets of these schemes, even when run by government, should be considered as indirectly owned by the pension beneficiaries, who are the ultimate economic owners, i.e., those bearing most of the risk, associated mainly with financial market developments.
[17] i.e. assets held by those funds that are consolidated (e.g. government bonds) should be deconsolidated).
[18] The text of this protocol annexed to the Treaty establishing the European Community can be found at:
http://europa.eu/eur-lex/en/treaties/selected/livre335.html
[19] This is in accordance with the EPC guidelines on taking account of assets in public pension funds (see Annex 14 of the Ageing Report (2006)).
[20] For a taxonomy of government liabilities see Part II.4 in European Commission, Public Finances in EMU, European Economy No. 3, 2004.
[21] Indeed, it only depends on the current level of debt, long-term projection of government spending and revenues and of the interest rate. Those data do not change often except if pension reforms are implemented or if future outlook on demography, potential growth or interest rate are changed. By contrast, sustainability gap also depends on the measurement of the current structural primary balance, which is also subject to uncertainties.
[22] Generational accounting aims at describing intergenerational fairness. See e.g. European Commission, European Economy (1999), 'Generational Accounting in Europe' for an analysis of the EU 15 Member States at the time.
[23] See Economic Policy Committee and European Commission (DG ECFIN) (2006), ‘The impact of ageing on public expenditure: projections for the EU25 Member States on pensions, health-care, long-term care, education and unemployment transfers (2004-2050)’, European Economy, Special Reports No 1, 2006.
[24] The long-term debt-stabilizing primary balance refers to the primary balance that, if reached and maintained, would stabilize the debt at its current level in the long-run. It therefore depends on the long-term prospects of GDP growth and interest rates. It can differ from the short-term debt-stabilizing primary balance that can be calculated with the current nominal GDP growth and the nominal interest rates.
[25] In the case of S1, the decomposition also separates the impact of the debt position (60% of GDP in 2050). In particular, if the current debt/GDP ratio is below 60% of GDP debt is allowed to rise and this component reduces the sustainability gap as measured by the S1 indicator, and vice versa (see Chapter I).
[26] The correlation coefficient between the LTC according to the S1 and the S2 across countries in Table II.1 is 0.98.
[27] The contributions of the IBP are of similar size for both indicators. In the following paragraphs the results from the S2 indicator are referred to.
[28] Poland is however in a very specific position. The projected decrease in age-related expenditure as a share of GDP results in a negative long-term budgetary impact of ageing. This almost exactly offsets the weak initial budgetary position.
[29] The government finances have improved in a number of countries as a result of lower interest expenditure on debt due to a reduction of interest rate levels in recent years. The improvement in the primary balance is therefore in general smaller.
[30] The Commission's spring 2006 forecast expects broadly unchanged CABs in 2006 and 2007 for the EU25.
[31] No long-term projection was available in the 2005/06 update of the Greek stability programme. Data from the 2004/05 sustainability assessment were used instead in that case.
[32] In some cases, Member States have provided additional information to the Commission in order to clarify/extend the information included in the stability and convergence programmes.
[33] Uncertainties surrounding the demographic and economic assumptions can also be dealt with, using stochastic methods to project a distribution of the different demographic and economic parameters over the long term. This enables to obtain a distribution of public expenditure, which can, to a certain extent, measure the uncertainties on the numerical results of the budgetary projections. This is for example done by the CBO (see Quantifying Uncertainty in the Analysis of Long-Term Social Security Projections, CBO, November 2005 ).
[34] The issue of risks related to pension projections is explored in Chapter V.2.
[35] However, compared to the first two types of sensitivity tests (economic and demographic assumptions, alternative health care and long-term care scenarios), it has no impact on the required primary balance.
[36] In the assessments of the 2005/06 stability and convergence programmes, an evaluation of the impact of reaching the budgetary targets at the last year of the programme period was made.
[37] In France the automatic tightening of the eligibility conditions to a full pension, implemented in the 2003 pension reform, ends in 2020.
[38] Moreover, there is no projection for long-term care in some countries, which adds to the observed diversity.
[39] It is also assumed that the interest rate/growth rate differential is unchanged. Indeed if GDP growth changes compared to the baseline scenario, returns on assets will increase accordingly and so will interest rates. This keeps the real cost for the general government to finance its debt unchanged compared to the baseline. The impact of a higher interest rate/growth rate differential is analysed in a separate sensitivity analysis namely in section 2.4.
[40] In addition, a higher productivity growth could lead to higher private pension premia, if pension funds adjust pension rights in line with the wage increase. This would have an additional impact on public finances in countries with large private pension schemes (see Ageing in the Netherlands, 2006, CPB). This effect is not taken into account here.
[41] The sensitivity shock on life expectancy increases the economic dependency ratio by around 5% while the sensitivity shock on employment rate decreases the economic dependency ratio by around 1.5%.
[42] The projected structural unemployment rates in the Member States display some variation also in 2050; ranging between some 3% to some 7% (see Table 7.4 in the Ageing Report). For countries with relatively high unemployment rates projected in 2050, there could be scope for increasing employment further.
[43] Specifically, between the last year of the stability/convergence programme of the country (2008, 2009 or 2010) and 2050.
[44] Box 1 in Chapter 4 of the Ageing Report shows a trend increase in the EU in both total health-care expenditure and public health-care expenditure as shares of GDP since the 1970s.
[45] In EU25, the old-age dependency ratio increased from 13% in 1950 to 22% in 2000, compared with a large projected increase to 49% in 2050, see Table I.26 in 'The 2005 EPC projections of age-related expenditure (2004-2050) for the EU-25 Member States: underlying assumptions and projection methodologies' , November 2005.
[46] It supposes that the health status of the population will improve by half as much as in the constant health status scenario. The costs are assumed to evolve following GDP per capita developments. Finally, it includes the effect of income elasticity of health-care spending converging from 1.1 in 2004 to unity by 2050.
[47] The income elasticity converges from 1.1 in 2004 to unity by 2050.
The reference scenario supposes that unit costs progress in line with GDP/capita. Under that assumption, health-care would remain constant as share of GDP without ageing. The alternative assumption of unit costs indexed on GDP/worker (i.e. productivity) suppose that health-care is more labour intensive than other budget sector and/or that costs in that sector are more dynamic.
[48] The country-specific features taken into account are the current size of public health-care expenditure, which ranges from 2.9% of GDP in Cyprus to 7.7% in France, and the age-profile of public health-care expenditure.
[49] See Chapter I.4 of the PFR 2006.
[50] In some cases the coverage may be different, e.g. for Italy.
[51] The reformed SGP specifies that MTOs pursue a triple aim, namely: (i) providing a safety margin with respect to the 3 percent deficit limit; (ii) ensure rapid progress towards sustainability; and (iii) taking the first two objectives into account, allow room for budgetary manoeuvre, in particular taking into account the needs for public investment. Country-specific MTOs in the current phase were set by the Member States themselves, taking into account: (i) the current government debt ratio (in 2004); (ii) potential economic growth (average 2005-2050); and, (iii) a measure of a safety margin with respect to the reference value of 3 percent of GDP. For a discussion of the MTOs and on the experiences one year after the reform of the SGP, see Parts II.2 and II.3 of the PFR (2006)).
[52] Proxied by interest expenditure divided by the debt level of the previous year.
[53] The structural primary government balance is used, i.e. net off the impact of the cycle as measured by the commonly agreed method for calculating output gaps and cyclically-adjusted balances and any possible one-off or temporary measures.
[54] Even if they are not yet members of the euro area or ERM II, they are expected to be so.
[55] Blanchard (1984).
[56] Perotti et al. (1997).
[57] Related to the stock of government debt and its dynamics, the composition of change in debt level needs also to be considered as it can lead better qualify a change in debt ratio. The breakdown of the change into three components (contribution of primary balance, interest/growth rate differential and stock-flow operations) allows for understanding the reasons underlying the change in debt ratio. The role of stock flow transactions requires additional attention as they include various items with different effect on the change in debt ratio. In addition, the effect of different type of operations is changing over time. Thus, changes in debt ratio in some of the new Member States have been heavily influenced by developments regarding the assumption of contingent liabilities related to the period of transition and/or privatisation proceeds. As the transition period has been coming to an end, the stock of contingent liabilities as well as assets to be privatised has been diminishing and the effect of such operations on change in debt ratio has been declining. For a more detailed analysis on stock flow adjustment see Chapter V.4.
[58] For a definition of the benefit ratio and of the replacement rate, see Box IV.1.
[59] Pension projections for Greece were not available in time for the completion of the Ageing Report and the benefit ratio could therefore not be calculated.
[60] Indeed, the new funded schemes are recent (EE 2002, LV 2001, LT 2004, HU 1997, PL 1999, SK 2005, SE 1999) and the total amount of pensions from those schemes will be limited in the next two decades (no more than 0.2% of GDP in 2020) reaching significant pension outlays as a share of GDP only after 2040.
[61] Other indicators are also available, e.g. replacement rates. For a discussion of the link between the two indicators see Box IV.1.
[62] In Austria, the structural shift from public servants into the social security schemes may have noticeably reduced the overall benefit ratio.
[63] See e.g. Pensionssystemets årsredovisning (2003, 2005). For Sweden, the increase in life expectancy used in the projections of the Ageing Report is higher than in this example (4 years).
[64] See for example, live longer, work longer OECD.
[65] Relying on private savings for low-income groups entails higher risks than for higher income group, since it is more difficult for them to increase savings. Moreover, the cost of administrative fees and information seeking may be proportionally higher for low-income group than for higher income groups.
[66] Such a proposal was included in the Pensions Commission's report (Turner report) with regard to the debate on pension reform in the UK. It also suggested the possibility of 'opting-out' from the private schemes.
[67] The net cost for public finances also depends on whether they lead to savings diversion or creation. (See Antolin et al (2004).
[68] The pension scheme has been often transformed into a notional defined contribution scheme (SE, PL, LV, IT, and to a certain extent DE) with various periods of transition, a defined contribution scheme (EE and SK) or a defined benefit system calculated over the entire career (PT and AT). In addition, even if reforms do not effectively introduce a notional defined contribution schemes, parametric reforms also tend to make pensions schemes closer to such schemes for example by lengthening the period over which the pension is calculated (FR), by introducing more incentives to work longer and linking the requirement to reach a full pension to life expectancy (FR up to 2020, AT).
[69] See technical annex of 'Adequate and Sustainable Pensions ', SPC-2006 http://ec.europa.eu/employment_social/social_protection/docs/2006/sec_2006_304_horizontalanalysis_en.pdf
[70] Except for assets accumulated in the mandatory funded part of the pension system
[71] The poverty rate is defined as the share of people whose equivalised disposable income is lower than a fraction of the median equivalised disposable income in the country, see technical annex of Adequate and Sustainable Pensions, SPC 2006
http://ec.europa.eu/employment_social/social_protection/docs/2006/sec_2006_304_horizontalanalysis_en.pdf).
[72] See technical annex of 'Adequate and Sustainable Pensions', SPC 2006.
[73] Moreover, the current measure of the poverty rate does not take into account the impact of house ownership. This may change the relative ranking of older and younger people if house ownership is more widespread in older households.
[74] See also UK country fiche of the SPC report on adequate and sustainable pensions. http://ec.europa.eu/employment_social/social_protection/docs/2006/uk_en.pdf
[75] In Malta, the current ceiling on pensions reduces the possibility for workers to increase their pension rights by working longer. Indeed, Malta features a ceiling on pensions which is indexed on the cost of living adjustment (COLA) which grows roughly in line with prices. Over the long run, this indexation rule will decrease the link between pension contributions and the pension level, changing a partly earnings-related system progressively towards a flat-rate system. Therefore, if unchanged, current rules will lead to an ever decreasing replacement rate at retirement and the benefit ratio will decrease by around a half up to 2050.
[76] Primary revenue is defined here as public revenue, excluding property income (see §3.3). This definition is symmetric to primary expenditure, which is defined as public expenditure, excluding interest expenditure on outstanding debt.
[77] For example, income tax brackets are usually fixed in nominal or real terms. As income increases in line with GDP, this entails an increase in the overall tax rate over time. While maintaining formal fiscal rules is relevant for short-term and medium-term planning, this is not the case for long-term analysis since this would ultimately lead every citizen to be taxed at the highest marginal level, changing substantially the redistributive properties of the income tax system.
[78] In practice, tax rates on the different tax bases may be quite different in EU countries (see Eurostat/DG TAXUD News release 62/2006, 17 May 2006). However, under the assumption that an increase in one tax base is offset by a decrease in another tax base, this will lead to large changes in the overall revenue/GDP ratio only in the case when there are large differences in tax rates and large changes in tax bases. For example, in 2003 in the EU, the tax rate on labour was 10 p.p. higher than on capital, an increase of the wage share by 10 p.p. would lead to an increase in the total tax ratio of 1 p.p. of GDP.
[79] Those age-profiles on the revenue side are indexed on GDP growth to avoid inflationary bias (or fiscal drag) in the long-term projections (see footnote 81).
[80] It also includes rents on land and subsoil assets, which are only large for two countries (DK and NL).
[81] See Chapter VI.
[82] See the EPC report “ The impact of ageing populations on public finances: overview of analysis carried out at EU level and proposals for a future work programme ”, EPC/ECFIN/435/03 final, 22 October 2003.
[83] It could be noted that returns from real estate (i.e. rentals on building) are not including in property income in the National Accounts since they are produced (and often consumed) by the general government.
[84] Property income paid by the general government is almost exclusively due to interest paid on the outstanding level of debt.
[85] It is related to ageing only through the effect of ageing on interest rates and the rate of return of risky assets and the fact that some governments are explicitly accumulating assets in view of ageing populations.
[86] Alternative assumptions could be taken regarding the net purchase of assets or net sales of assets in the future. This would be neutral in terms of long-term sustainability since assets and general government debt have the same rate of returns in the current sustainability framework. Therefore the extra revenue from those newly bought assets would exactly compensate the increase in interest expenditure due to the extra debt.
[87] The deficit and debt definitions that are relevant for the EU budgetary surveillance procedures have been established by the Treaty Protocol on the excessive deficit procedure and specified in Council Regulation (EC) No 3605/93. The deficit and debt are defined through cross references to the European System of Accounts (nowadays ESA95).
[88] A positive (negative) SFA means that factors other than the government deficit increase (reduce) the government debt.
[89] For more on political incentives for the SFA see Buti, Nogueira Martins and Turrini (2006).
[90] See Eurostat, 2006.
[91] The overall tax burden is defined as taxes on production and imports, current taxes on income and wealth, capital taxes and compulsory and voluntary actual social contributions and imputed social contributions.
[92] First, all kinds of liabilities backed by legal obligations but which may never lead to an actual government payment (e.g., government guarantees), generally known as contingent liabilities, are not included. Second, there is no account of future obligations that are not backed by law but that are very likely to translate into actual government expenditure (e.g., future health expenditure, pensions related to contributions yet to be paid, etc.). These are often referred to as implicit liabilities .
[93] The quantitative information included in the Convergence programmes is however not comparable across the MS. See European Commission (2005).
[94] For a discussion on PPPs in the context of assessing debt sustainability, see IMF (2005).
[95]
As a general rule, contingent liabilities are not recognised in the ESA95 or SNA systems of national accounts. ESA95 and SNA record contingent liabilities when these liabilities are tradable and have a market value. State guarantees are very rarely tradable.In the new Questionnaires related to EDP tables, now explicitly foreseen in Council Regulation 3605/93 as amended, Eurostat requests information on guarantees in relation to (i) the stock of guarantees and the volume of calls, including information on repeated calls, notably, (ii) the national accounts recording and (iii) the reporting within EDP tables.
[96] For a discussion on valuation of the contingent liabilities see European Commission (2004) and IMF (2005).
[97] The case of Maltese state guarantees was considered for purely illustrative purpose as it reported the largest stock of state guarantees among the EU-10. Since all of the EU-10 countries that reported some information on the stock of contingent liabilities included data on the outstanding state guarantees, only this category was taken into account. Other reported categories include litigation costs, deposit insurance, reprivatisation and decommissioning, etc. While some of this information is not quantified, other is not, which makes it impossible to compare the size of contingent liabilities across the Member States.
[98] This three-level categorization was introduced by the Commission and the Council for the 2005/06 round of assessment of the stability and convergence programmes.
[99] An increase of the structural primary balance by 1 p.p. of GDP would result in a decrease of the sustainability indicator by the same amount.
[100] In the 2002 updated stability programme, pension were projected to increase by 10.2% of GDP between 2005 and 2050 and in the 2001 common projections, an increase of 12.4% of GDP was projected.
[101] See the public Finances Report 2006.
[102] For Greece, the 2002 stability programme projected an increase of pension expenditure of 10.2% of GDP between 2005 and 2050.
[103] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[104] The assumption of debt (2.5% of GDP) from the railway company SNCB by the government in 2005 has been treated as debt-increasing, but without impact to the deficit and primary surplus. Eurostat considers that this debt assumption must be recorded as a capital transfer, increasing the government deficit by the same amount. However, Belgium has informed Eurostat of its intention to introduce legislation to retroactively annul this transaction (see Eurostat Press Release no 48/2006 of 24 April 2006).
[105] Excluding the impact of the debt assumption from the SNCB (see previous footnote).
[106] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[107] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[108] According to the Danish authorities, temporarily high pension yield tax contribute with 1.2% of GDP, corporate tax by 0.5% of GDP and North Sea revenue by 0.3% of GDP, totalling 2% of GDP.
[109] The welfare reform package has broad political backing. The agreement was reached by 5 of the main political parties representing more than 80% of the votes in the Danish parliament (Folketinget).
[110] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[111] See the Box on pp.155-156 in the Ageing Report (2006).
[112] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[113] If the pensions from the private funded schemes are not considered, the reduction in the benefit ratio is larger, of more than 50%.
[114] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[115] Despite the recent improvement in the statistical processes, a number of issues remain pending related to the Greek government accounts. See Eurostat News release 48/2006 of 24 April 2006.
[116] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[117] An agreement between the government and the social agents has been reached on the reform proposal in May 2006.
[118] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[119] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[120] The Pensions Board is a statutory body set up to monitor and supervise operation of the Pensions Act (1990). The Board also advise the Minister for Social and Family Affairs on pension matters generally. See ‘The National Pensions Review’, report by the Pensions Board, October 2005, available at: http://www.pensionsboard.ie.
[121] See 'Towards Towards 2016, Ten-Year Framework Social Partnership Agreement 2006-2015' http://www.taoiseach.gov.ie/index.asp?locID=181&docID=2755
[122] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[123] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[124] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[125] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[126] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[127] It should be noted that the relatively low increase in the old-age dependency ratio in Luxembourg which refers to the projected resident population in Luxembourg, i.e. excludes cross-border workers.
[128] It should be noted that real GDP growth in Luxembourg is projected to be higher than in the rest of the EU up to 2050, which implies that the differential between interest rate and growth rate is particularly low. In the calculation of S2, this mechanically gives no weight to the current level of debt, being very low, while it gives a large weight to the latest year of the long-term projection, which displays a large increase in expenditure compared to the base year.
[129] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[130] The re-elected government announced in early June, that due to important budgetary slippages in 2006, the end-year deficit without corrective measures would be around 9.5% (11%) of GDP as compared to 6.7% (8.2%) in the Commission's Spring 2006 budgetary forecast.
[131] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[132] The pension reform has not yet been enacted.
[133] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[134] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[135] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[136] If the pensions from the private funded scheme are not considered, the reduction in the benefit ratio is even larger, by 57%.
[137] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[138] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[139] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[140] If the pensions from the private funded scheme are not considered, the reduction in the benefit ratio is even larger, by 34%.
[141] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred (e.g. for the unemployment rate) and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[142] Also, the Finnish Ministry of Finance economic forecast of June 2006 has revised the outlook for general government surplus significantly upwards to 2.6 % of GDP in 2007.
[143] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[144] This figure excludes the part of pensions that is attributed to the funded defined contribution scheme, the PPM, which will be classified outside general government as of 2007. In the Ageing Report (2006), this scheme was included in the projections of public pensions.
[145] See previous footnote.
[146] If the pensions from the private funded scheme are not considered, the reduction in the benefit ratio is larger, 31%.
[147] The demographic and macroeconomic data in this paragraph are those underlying the long-term projections in the Ageing Report (2006). They were published in November 2005. Since then, data revisions may have occurred and new prospects for GDP growth in 2006 and 2007 may affect the average growth rate in 2004-10.
[148] Pensions Commission, A New Pension Settlement for the Twenty-First Century, The Second Report of the Pensions Commission, 2005.
[149] Pensions Commission, Implementing an integrated package of pension reforms: The Final Report of the Pensions, 2006.
[150] It should be noted that part of the reform announced in the White paper, namely the uprating of the Pension Credit (i.e. the means-tested part of pension support) in line with earnings was already incorporated both in the Ageing Report and in the UK authorities own projections.
[151] In the present report, the projections in the Ageing Report are used and the impact of the proposed reform package is not included in the analysis.
[152] It is also supposed to be strictly positive.
[153] If the difference between the interest rate and growth rate is 1.5%.
[154] Formally (E) can be written as a weighted average of (C) and the change in primary balance in 2050 (see annex).