The European Social Pension: A Theoretical Exercise

3. The Case for a European Social Pension

This exercise is less ambitious than that of Holzmann (who advocated the need for a harmonized Pan-European pension system) and more ambitious than that of Atkinson et al. (who suggested an EMP financed by member states). We propose the establishment of a European Social Pension which would be financed by the EU Fiscal Budget.
Implementation of this proposal would require expansion of the fiscal budget of the EU and, therefore, more redistribution of income. There are two crucial issues: (a) why more redistribution, and (b) why this redistribution should be directed to reduce poverty in retirement. The argument for more redistribution is based on both economic and social grounds. Holzmann’ s analysis has reiterated the fact that the EU has become a common currency area where national governments have limited use of fiscal policy and no access at all to monetary policy. Therefore, economic adjustments are made mainly at the level of employment; but even there, there is not a Pan- European policy of labour market integration. The most likely outcome of this process will be increased social tensions and endangerment of social cohesion in the less productive member-states. But even national anti-poverty policies are most likely to be prevented by fiscal competition from achieving their objectives (Atkinson, 1998). Such economic reasoning has led to the proposal for the adoption of a federal system for the EU; the central government will have fiscal powers similar to those of the federal governments of Australia, Canada, and the United States. Since this option looks very remote, we suggest that a first small step in this direction, with the adoption of a European Social Pension, will send the message out across the Continent that the EU does not stand only for free markets but for social solidarity too. The first application of the new principle would be for the retiring generations of Europeans who managed to overcome historical obstacles and build a unique geopolitical experiment that has spread peace and prosperity across a continent that, within living memory, had little of either. Provision of the European Social Pension, financed by the EU Fiscal Budget, may be viewed as a first step in forming the Union’s missing core identity: cooperation on a continent-wide level to improve people’ s lives.
The specific proposal for a European Social Pension is based on Dreze’s second-best analysis that risk sharing at the European level could be achieved on a two-tier basis, with the countries sharing macroeconomic risks, in addition to organizing domestic social security. Moreover, Lindbeck and Persson (2003) have proved that the establishment of a minimum pension scheme in a multi-pillar pension system represents a Pareto improvement.
The proposed European Social Pension is in essence a mutual insurance for retirement poverty at the EU level. Dreze has shown that such a scheme is a second-best, because of moral hazard and adverse selection problems. The precise design of second-best schemes raises a number of problems. One set of problems concerns the choice of instruments (pension subsidies, minimum pension, tax credits, lump-sum transfers, etc.) suited to minimizing distortions. A second set of problems concerns the estimation of parameters entering into the definition of the second-best policy (poverty threshold, exchange rate parity, definition of unit of recipient, etc). A third set of problems concerns political feasibility within the EU. To resolve those problems in such a way as to maximize the impact of the proposed scheme on poverty reduction in retirement, as well as to minimize the distortions of the system, the basic design characteristics of the proposed scheme are outlined here.

3.1 Determination of European Minimum Pension Threshold

This threshold is proposed to coincide with the official definition of the European poverty threshold; that is, 60% of mean equivalent disposable household income. The poverty threshold is revised annually.

3.2 Establishment of the European Social Pension

If income from national pension sources falls short of the European Minimum Pension Threshold, then the European Social Pension, in the form of a supplementary pension, is paid to meet the shortfall.

3.3 Targeting Retirement Poverty

The main goal of the European Social Pension would be to reduce poverty among the retired people of the EU. The eligible retirees will be those of age 65 and over. The age limit of 65 years may be gradually adjusted upwardly.

3.4 Financing by the EU

The required expenditure is financed by the EU, which has to increase its fiscal budget accordingly.

3.5 No Means Test

The European Social Pension will be provided without a means-test.

3.6 Adjustment of the European Minimum Pension at the national level

The annual poverty threshold should be adjusted at the national level on the basis of purchasing power parity (PPP) exchange rates, published by Eurostat. It is well known that national parity estimates and particularly cross-country comparisons of poverty, are sensitive to the choice of assumption and income concept used in ranking households (Atkinson et al., 1998). It has been shown that if we want to maximize the reduction in retirement poverty, it is preferable to convert incomes in different countries by using PPP-adjusted rates, instead of nominal exchange rates (Atkinson et al., 2002).

3.7 Determination of Recipient Units

There are two options here. The first considers per capita income and weights by the number of people in the household. The second option uses the ‘modified OECD scale’ (a value of 1 for the first adult, 0.3 for children aged under 14, and 0.5 for remaining people in the household) to equivalize household income. A sensitivity analysis of the alternative options has shown that the second option has the greatest reduction impact on retirement poverty (Atkinson et al., 2002).

3.8 Minimizing Distortions of Proposed Scheme

The optimal design of the proposed scheme requires the minimization of potential distortions. A first distortion may result from moral hazard problems at the national level: attempts to shift pension burdens from the national to the EU level. This moral hazard problem should be addressed carefully at the design level, taking into consideration the fact that the proportion of beneficiaries from the proposed scheme depends on two things: (a) the relative generosity of the existing pension payments compared with the ‘minimum standard’, and (b) the coverage of the existing pension systems. A second distortion may result when conflicts arise with national rules on ‘other incomes’ for the application of means-tests, or with rules about deferring retirement.

3.9 Institutional Capacity for Implementation

There is adequate institutional and technical capacity at the EU level for the organization and operation of a pension scheme along the lines proposed here. It should be noted that the optimal design of the proposed scheme may be attained on the basis of sensitivity analyses of alternative options, by employing the ‘prototype European tax-benefit model’ developed by Atkinson et al. (2002) on the basis of the microsimulation model EUROMOD (Sutherland, 1997).

3.10 Political Issues

The main political issue is whether there is a strong argument for additional redistribution of income in the current political environment within the EU. In fact the official redistribution of income by means of the EU Fiscal Budget amounts to 1.24% of the GNI of the EU. Of course, the real redistribution of income across the Union is determined by the relative competitiveness of the national economies, and this must far exceed the aforementioned nominal percentage. Therefore, there is a question of fiscal feasibility of the proposed scheme. A preliminary estimate of the cost of a similar scheme (with a poverty threshold at 40% instead of 60%) has been made in Atkinson et al. (2002) for five European countries. The required increase in a uniform rate of VAT (on all household expenditures) that would be needed to finance the European Minimum Pension in each country ranges from 1.7% in Ireland to 0.6% in Germany (the average for the five countries is 0.9%). In other words, some average of these numbers represents the additional uniform European VAT tax that would be required to finance the proposed scheme. It is suggested that an additional tax on the GNI, instead of the VAT, should be used to finance the proposed scheme.

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