Hans-Werner Sinn

Nationalökonomie & Finanzwissenschaft

Ifo Viewpoint

Ifo Viewpoint No. 70: Reward Childrearing in the Pension System!

Munich, 7 December 2005

In relation to its population Germany has fewer children than any other developed country. While economic stagnation and the pension crisis are among the consequences of this development, the pension system itself may be among its causes. The pension system itself may have contributed to the demographic crisis from which it now suffers.

Pension insurance is insurance against childlessness. Even those who are unable to have children need not hunger when old because they will be fed by the children of other people. This insurance coverage is a great advantage for all participants. Its problem, however, is that it weakens the economic incentives for having children in family planning by almost completely socialising the childrens’ contributions to the preceding generation.

Before the introduction of pension insurance under Bismarck, it was also common in Germany to have children to maintain one’s standard of living in old age. Today, hardly any young couple makes the connection between the desire for children and safeguarding their own retirement. Complete coverage against childlessness has led to a full comprehensive insurance mentality.

If Germans now have fewer children than former generations, thereby forming less human capital, they must instead accumulate more real capital as a substitute for the decline in pension contributions. This is the logical consequence that has led to Germany’s partial pension funding scheme and to pension cuts in the pay-as-you-go system. But the funded pension components have not been completely thought through.

They do not reduce the false incentives in family planning and they lead to unacceptable burdens for families with children. Families finance the generation of their parents with their pension contributions. By rearing children they also finance future pensions. And now with the funded pension scheme they are meant to finance their own pensions once over. Two burdens are normal in the generational context. A third burden is one too many.

Instead of making a whole generation collectively responsible, the necessary pension cuts and a compensating funded scheme should be focused on the childless. Those who cannot or will not have children can be expected to invest the money that others spend on childrearing in the capital market to finance a supplementary pension.

The plan could work this way: The statutory pension scheme is retained but will not be blown up again and again with new tax money. Contribution rates and relative federal subsidies are frozen. Then the level of pension payments relative to wages will fall by half in 30 years since every employed person will have to finance twice as many old people. Even with the increase of the retirement age and a rise in the female employment rate it will fall from a present 48 percent to 32 percent, the current social welfare level. This will be totally insufficient, which means that additional pension pillars are needed.

One pillar is the child pension for parents. Whoever has raised children receives a pay-as-you-go pension that will raise the overall pension, together with the declining old pension scheme, back to 48 percent. This pension will be paid for by all employed persons, including the self-employed and civil servants. The other pillar consists of an expanded funded system with savings of eight percent of payroll earnings, which will also raise total pension payments to 48 percent. Saving becomes an obligation.

Everyone who enters the working world must contribute until they have children. When the first child is born, a third of the accumulated capital is paid out and the obligation is lifted for a third of the mandatory savings, since human capital with the corresponding pension claim is now available as a substitute for real capital. The same procedure is applied for every additional child up to three children.

Young couples now know what they need to do. To safeguard their retirement they must either save or have children. Faced with this situation, many will decide to act on their latent wish to have children. This safeguards their pensions because either real or human capital is available for their financing. This is the only way to master the pension crisis.

Hans-Werner Sinn
Professor of Economics and Finance
President of the Ifo Institute

Published under the title "Erziehung bei der Rente belohnen“, Westdeutsche Zeitung, No. 184, August 10, 2005, p. 5; see also "Führt die Kinderrente ein!", Frankfurter Allgemeine Zeitung, June 8, 2005, p. 41.