Bank of Estonia: Pension reform to bring pressure for tax increase with it

Pensioners in Tallinn (picture is illustrative).
Pensioners in Tallinn (picture is illustrative). Source: Siim Lõvi/ERR

The Bank of Estonia recommends not making the second pillar of Estonia's pension system voluntary, as that may result in lower old-age pensions in the future and bring pressure to raise taxes in the future with it.

The Ministry of Finance sent the pension reform bill that would make the second pillar optional for an interministerial round of approvals last Wednesday.

Earlier this fall, the Bank of Estonia drew up an impact analysis of changes to the system of mandatory funded pensions in which it assessed the short- and long-term impacts of the planned change.

"In our analysis, we arrived at the conclusion that the more the planned changes will reduce the accumulation of pension savings into the pension pillar, the greater the pressure will be in the future to increase the pension paid from the first pillar and to increase taxes," Bank of Estonia Governor Madis Müller said in a letter to the Ministry of Finance.

The central bank pointed out that despite the increase in retirement age, the ratio of working people to pensioners in Estonia will start to decline in the decades to come.

By 2060, there will only be 1.6 people in employment per person in retirement, down from the current 2.2. This will put the first pension pillar under strong pressure, which will be aggravated by a growing risk of poverty in people in retirement in a situation where they lack savings accumulated via the second pillar.

Withdrawal of money from pension funds as a result of the pension reform will also increase the volatility of economic growth.

"Initially, economic growth will increase as a result of a steep increase in consumption, as will property prices and imports," the Bank of Estonia said. "When the initial effects of the withdrawal of pension savings are over, economic growth will weaken."

Clear picture needed first

According to the central bank, before fundamental changes to the pension system are made, it is necessary to clearly describe the expected indicators of the desired new system and reach an agreement on them that is as broad-based as possible.

"The necessary comprehensive picture should offer clarity regarding the relative size of the pension to be offered by the state in the future, expected contributions from individuals as well as the expensiveness of the pension system."

If the desire nevertheless exists to increase the degree of voluntariness in the second pillar, Müller continued, it would be advisable, in order to reduce the volatility of Estonia's economic growth, for the government to refrain from spending the additional tax money and extend the length of the period during which pension savings can be withdrawn.

If the second pillar is made optional, the Bank of Estonia continued, it would be useful to consider ways to motivate people to nevertheless save for retirement via a funded pension scheme. Opportunities should also be sought to protect unitholders who have placed their money into second pillar pension funds that have invested the most in the Estonian economy and whose assets are less liquid.


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Editor: Aili Vahtla

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