Ireland’s rapidly ageing population poses challenges to how State pensions will be paid for in the decades ahead. The thinking seems to be to raise taxes to address funding shortfalls. But how much higher will taxes have to be? Will governments actually raise these taxes?
The Joint Committee on Social Protection, Community and Rural Development and the Islands recently issued a report on pensions, which set out a political response to the Pensions Commission’s recommendations from last October.
The committee’s key points were that the pension age should remain at 66, and the cost of pensions should be funded by higher taxes and social contributions.
These choices would have big implications.
Not increasing the pension age locks in a longer, and growing, average retirement period. The Irish Fiscal Advisory Council estimates that the average Irish person could, at age 65, expect to live to 89 by 2050. That is 10 years longer than an average 65-year-old would have lived in 1980. By contrast, the pension age has only increased by one year since then.
The committee wants to lock in the pension age of 66 even as life expectancy continues to rise. A longer lifespan with an unchanged pension age would mean more costs.
Keeping the pension age at 66 means more of the burden will fall on higher taxes in future
But Ireland also faces the twin challenge of having one of the fastest ageing populations in Europe. This is due to the looming retirement of a bulge in the population. It can be traced back to the Irish “baby boom” in the 1970s and 80s.
In 30 years, Ireland’s population is projected to look older than the EU’s oldest countries do today. This is a radical transformation. A shift in the population towards retirement will mean a sharp rise in the number of older people supported by the average working-age adult. The number of overs 65s relative to those aged 15-64 is expected to double by 2050.
Keeping the pension age at 66 means more of the burden will fall on higher taxes in future.
The Pensions Commission report last September projected a €13 billion shortfall in funding for pensions by 2050.
To meet the costs of this the commission’s preferred approach involved a mix of responses: gradual increases in the pension age starting from 2028, increases in PRSI for employees, employers and the self-employed, and some other unspecified measures. This left a small need for other funding sources, mostly likely further tax increases or reduced spending elsewhere.
This was described by the commission as the “most equitable and effective approach”.
However, the Oireachtas committee now proposes to spread the costs much more heavily on future taxes. Its proposals keep the pension age the same and scale back some of the commission proposals. This means that 90 per cent of the package preferred by the Oireachtas committee may now have to be funded by higher taxes and PRSI increases.
To deal with the €13 billion shortfall in funding for pensions by 2050, the committee opts to raise €6.6 billion from higher PRSI. This is similar to the commission’s preferred option. But the rate increases are larger, and it focuses only on employers and the self-employed. A further €1.1 billion would come from moving to a total contributions approach, which reduces benefits for those without 40 years of contributions.
But that leaves a sizeable hole of €5.7 billion, or 42 per cent of the funding requirement. This mainly reflects the cost of not raising the pension age (28 per cent) along with choices still not made (15 per cent). The shortfall is likely to be made up by other unspecified tax increases or spending reductions elsewhere.
Where exactly might the shortfall be made up? That is unclear. One area the Oireachtas committee does cite is a wealth tax.
However, research in 2018 by the Economic and Social Research Institute looking at wealth tax options suggests that, with a €1 million threshold and exemptions for main residences, farms, businesses, and pensions, such a tax would yield just €53 million a year. Increasing the yield would be complicated and hit more households and businesses.
As with other challenges, acting sooner on this will cost less
Relying so heavily on future tax increases to support the pension system raises questions about credibility.
The commission option closest to the Oireachtas committee’s proposals had sharp PRSI increases. These made up a little more than half of the funding measures. The package meant PRSI rates for employers and employees would each be 2.65 per cent higher by 2050. That would have raised overall PRSI by about €1,800 for a worker on the typical annual wage in today’s terms.
However, the Oireachtas committee is opposed to increasing employee PRSI rates as the commission has proposed. As a result, this leaves a larger share of the costs to be found elsewhere.
Will future governments be able to raise taxes by so much? Will they be able to cut spending in other areas? Any funding shortfall would most likely have to be met by more borrowing and a larger debt burden. Another risk is that these proposals raise labour costs and reduce incentives to work at a time when growth is already projected to moderate.
Ireland faces many pressing challenges, from climate change to healthcare, from housing to ageing. Using so much of Ireland’s potential to raise revenues in future just for one of these policy challenges is an important decision. Things could be made more difficult if corporation tax receipts end up falling back at the same time. The political system needs to get behind a credible and fully-costed plan.
As with other challenges, acting sooner will cost less. The Irish Fiscal Advisory Council showed in 2020 that managing ageing challenges while preventing rising debt ratios would cost two-fifths what it otherwise would if action was taken earlier rather than later. Time is of the essence.
Dr Eddie Casey is the Irish Fiscal Advisory Council’s chief economist
