A momentous demographic transition is currently under way in most industrialised countries. Low fertility rates compared with those which prevailed in earlier decades combined with increasing life expectancy will soon lead to populations that are older and more dependent on transfers than ever before. At the same time lower rates of population growth and declining productivity are likely to result in slower rates of economic growth. Maintaining the real level of pensions and other social transfers in these conditions holds out the unpalatable prospect of either substantially higher tax burdens on the economically active population, substantially worsened public finances, severe restrictions on non-pension expenditure, or some combination of all three unpalatable options.
Awareness of the fiscal and economic risks implied by these developments has led to debate about the structure of the pension system in other countries. For example, Germany, which is set to experience a more immediate and severe demographic problem than Ireland, is currently considering plans for pension reform. Their plan includes a reduction of benefits from the pay as you go system, support for private pension funds and more support for company pensions. Other options which have been mooted internationally include raising the age of retirement, cutting back on pension entitlements and linking pensions to the age of retirement so that the older one retires the larger the pension received.
Ireland is not immune from these trends. In common with other industrialised countries, we are set to experience a significant ageing of our population over the coming decades. The resulting increased dependency ratio will give rise to serious budgetary issues. In particular, it will put severe strain on the capacity of future Governments to continue to fund social welfare and public service pension liabilities on the current pay as you go basis. The purpose of the Bill before the House is to put in place a mechanism to address this issue. It aims to meet part of the escalating cost of pensions by providing for the establishment of a national pensions reserve fund. The Bill marks a radical departure in the management of the public finances and introduces a new strategic long-term element into budgetary planning.
The position in Ireland is slightly better than elsewhere but the longer term trend towards an older population is similar to that in other countries. Almost uniquely in the industrialised world our age dependency ratio will actually decline a little over the next few years. Currently we have, and will continue to have for most of this decade, about five people of working age for each person over 65 years. However, the position will begin to change at the end of the decade. By 2016 it is projected that there will be about four persons of working age to support each pensioner. This trend will continue and by mid-century it is projected that there will be only two people of working age for every pensioner.
It is obvious that this greying of the population will have profound implications for Exchequer spending on pensions, health care and other services. The social welfare pension issue was considered in National Pensions Policy Initiative, a report by the Pensions Board to the Minister for Social, Community and Family Affairs in May 1998. That report recommended the partial prefunding of the projected growth in social welfare pensions.
This issue and the wider budgetary issues posed by ageing were considered by a number of groups in my Department, principally the budget strategy for ageing group, BSTAG, whose report was published in July 1999. Taking the work of these groups together and updating conclusions to take account of the most recent data, the position in which we are likely to find ourselves can be summarised as follows. The current Exchequer cost of public service and social welfare pensions is 4.7% of GNP; by 2026 the Exchequer cost of broadly maintaining this level of pension provision will rise to 8.1% of GNP and by 2056 this cost will have risen to 12.4% of GNP. This increase is merely to maintain the existing level of service. Any relative improvements that might occur in pension provision would, of course, add further to the cost.
The prospects of funding the increased expenditure which I have outlined from economic growth are not bright. As the population ages we will not be able to fuel growth through an expansion of the labour force as we have done over the last few years. In this changed scenario, growth will have to be sustained by productivity gains alone and levels are likely to converge to the norm for advanced industrial societies. I have tried to illustrate the magnitude of the task facing the country. Fortunately, because of our predominantly young population and the economic boom, we have both the time and the capacity to prepare for the burden. Indeed our young population and the resultant increase in the labour force has been a significant contributory factor to our current strong economic performance. These favourable conditions are set to continue into the next decade and we can expect to achieve significant budget surpluses over the next few years. The consolidation of our budgetary position through the running of surpluses and the consequent decline in our level of indebtedness will of themselves improve our capacity to deal with the issues posed by ageing. However, we have the opportunity to go further, to take advantage of these favourable economic conditions and to provide now for more normal circumstances as the growth in the economy tapers off when the bulge in the young population passes through.
Up to now, the Exchequer costs of social welfare and public service pensions have been met as they arise – like many other countries Ireland operates a pay as you go approach to funding these costs. If a pay as you go system is to be stable, there must be sufficient workers, who are sufficiently productive, to finance the cost of pensions for those who have retired.
In the past, this requirement has been met in this country and it will continue to be met in the medium term. However, we now know that it will not be met in the long term. If we do nothing to anticipate that development now, the con sequence will be either that taxes will have to rise dramatically when that time arrives or the value of pensions in real terms will have to be reduced. The Government does not want to leave future generations of pensioners in a position where maintenance of the current level of pension cover could be put at risk.
The purpose of this Bill is, therefore, to move from complete reliance on pay as you go and introduce part funding of our future liabilities. Put simply, the Bill involves setting aside some of the revenues generated by the strength of the economy and our favourable demographics, investing them and drawing them down in the future when growth rates are likely to be slower and the age dependency burden very much increased.
Given the magnitude of the prospective costs involved and the many other competing demands on the State's finances it would be unrealistic to expect the Government to fully fund the increased costs of ageing in advance. The budget strategy for ageing group estimated that about 3.5% of GNP would have to be set aside annually to equalise the Exchequer burden of health and pension costs over the next 50 years. This is simply too much to expect of any generation. What I am proposing in the Bill is more modest but also more achievable. It involves the setting aside and investing of 1% of GNP annually to meet part of the cost of future pensions. The Bill will also allow the Government to make additional contributions to the fund. As Members are aware, we have already decided that the net proceeds of the sale of Telecom Éireann, now Eircom, are to be paid into the fund. This money has been lodged to the temporary holding fund for superannuation liabilities under the control of the NTMA. Once this legislation has been enacted, it will be paid into the reserve fund.
The Bill provides that drawdowns from the fund will commence in 2025 and will continue to at least 2055 in accordance with ministerial rules. These rules will require draw downs to be calculated by reference to the number of persons over 65 years of age in the population during the period from 2025 to 2055 or later, with the aim of avoiding extreme variations in the net Exchequer position from year to year. This will link withdrawals from the fund to increases in the pension bill while providing for a smoothing of the budgetary impact of ageing over the period. The extent to which the fund will contribute to the increased cost of pensions in the long term depends on a number of factors, principally the extent of the additional payments into the fund on top of the annual 1% of GNP and the return the fund achieves on its investments.
While we know the contribution will be substantial, it is impossible to forecast exactly how large it will be. The Bill provides in section 6(1)(f2>h) for the regular assessment of the State's long-term pension liabilities and of the capacity of the fund to meet these liabilities. It will be a matter for future Governments to monitor this relationship and to take appropriate action.
I should stress that in earmarking such substantial moneys for the fund, the Government is in no way neglecting the current needs of our society. Contributions to the fund are not being made at the expense of other goals and commitments. Because of our economic success we are in the happy position of being able to prefund, within a sustainable budgetary strategy which will also allow for substantial infrastructural and other capital investment under the national development plan, for continuing implementation of the Programme for Prosperity and Fairness, for further improvements in public services and for ongoing reduction in the national debt. In short, the economic success which we have worked so hard to achieve allows us to make provision for future pension liabilities without compromising on our more immediate economic and societal goals.
While making an annual 1% of GNP contribution to the fund poses no difficulties for the Exchequer at the moment, I recognise that Senators may have concerns that the contribution could cause problems in more adverse economic circumstances. However, it is the Government's opinion that any short-term difficulties that the payment may cause the Exchequer are more than offset by the long-term gain.
To leave discretion in the making of the 1% contribution in times of economic difficulty would, I am convinced, undermine the whole basis of the fund. I do not need to remind the House of the straits in which prioritising short-term interests over the longer-term sustainability of the public finances has left us in the past. I believe that a 1% of GNP contribution is a prudent and sustainable commitment. Once built into the multi-annual budgetary structure it should not cause undue difficulty. To put it into perspective, the contribution is slightly less than our annual contribution to the EU budget and less than one third of the interest payment on the national debt.
I wish to set out a few of the key principles which I have enshrined in the legislation establishing the fund. I am extremely conscious that it is the people's money that is being invested in the fund and I have, therefore, purposely structured the fund in a manner which will enable it match the returns achieved by private pension funds. This is reflected in three key features of the Bill.
First, the fund will be managed by commissioners who will be independent of Government. They will control and manage the fund with discretionary authority to determine and implement an investment strategy for the fund. Given the responsibilities to be placed upon the commissioners, it is essential to ensure that those appointed have the ability and expertise to make a constructive contribution to the management of the fund. To this end the legislation specifies that appointees must have acquired substantial experi ence at senior management level in relevant areas.
Second, this investment strategy will be based on a commercial investment mandate with the objective of securing the optimal return over the long term subject to prudent risk management. On this point, I should state that given its large size in comparison to the size of the Irish market, it is inevitable that most of the fund will be invested abroad.
In this connection, Senators may ask if the commissioners should be required to take other national objectives into account when determining an investment mandate for the fund. It is my firm view that any dilution of the commercial nature of the investment mandate, for example by requiring the commissioners to maintain a certain level of investment in the Irish economy, could seriously compromise the returns achieved by the fund. Placing a statutory obligation on the commission to give priority to investment in Ireland could expose the commission to pressure to make commercially sub-optimal decisions.
It is worth repeating that the purpose of the fund and the justification for asking the taxpayer to make a contribution to it of 1% of GNP each year is to provide, as far as possible, for the costs of future pensions. I believe the State has a solemn duty to do everything it can in accordance with prudence to maximise the return on this investment. The use of fund moneys for any other objective, no matter how laudable, should not be countenanced. Such objectives, if worth achieving, can be attained in other ways.
Third, in order to ensure that the fund cannot be raided by future Governments for any other purpose besides the meeting of pension costs, I have provided for a prohibition on drawdowns prior to 2025. As I have already said, drawdowns after that date will be determined under ministerial rules by reference to projected increases in the number of persons over 65 in the population.
Having highlighted these key features I wish to set out the main provisions of the Bill. In summary the Bill provides for the establishment of the fund to provide towards the Exchequer cost of social welfare and public service pensions from 2025 onwards; a statutory obligation to pay a sum equivalent to 1% of gross national product from the Exchequer into the fund each year until at least 2055 – provision is also made for the payment of additional sums into the fund from time to time; the establishment of an independent commission to control and manage the fund – the commission will have discretionary authority to determine and implement an investment strategy for the fund; a strictly commercial investment mandate for the fund with the objective of securing the optimal return over the long-term subject to prudent risk management; a prohibition on drawdowns from the fund prior to 2025 – drawdowns thereafter will be determined under ministerial rules by reference to projected increases in the number of persons over 65 and with a view to avoiding large fluctuations in the net Exchequer balance; the appointment of the National Treasury Management Agency as manager of the fund to act as agent of the commission – the appointment of the agency will be for a period of ten years, following which there will be the option, at five yearly intervals, to extend this further or to appoint an alternative manager; the appointment by the commission of investment managers to invest and manage portions of the fund and custodians to ensure the safekeeping and security of the assets of the fund; accountability of the commission to the Minister for Finance and to the Dáil – this includes provision for detailed annual reports and for appearance of the commission chairperson and the chief executive or the manager before the Committee of Public Accounts; and the transfer of the £5 billion currently in the temporary holding fund to the reserve fund and the winding up of the temporary holding fund.
It should be stressed that the fund is intended to be an instrument of long-term budgetary sustainability. It will lower the peak of pension payments to be met from the Exchequer in the second and third quarters of this century and thus bring about a smoother pattern of change in the Exchequer pension bill during those years. Starting now it enables us to set aside revenues from our favourable demographic position and our strong budgetary position.
The fund does not provide a complete solution to the budgetary problems posed by population ageing but it makes a start. It will allow us to begin preparing on a systematic basis for longer-term budgetary problems facing us in an ageing society. It marks a radical departure in the management of the public finances by introducing a new strategic long-term element into budgetary planning and I commend it to the House.