In Hungary, as in many countries, the task of financing the state pension system is a growing problem. As market economics took hold in Hungary at the beginning of the 1990s, the real value of pensions fell away. This in turn made it clear that additional, private, funded pension provision would be required which, as we shall see, sowed the seeds of future funding difficulties for the first pillar.
Legislation passed in 1993 introduced voluntary third pillar schemes. “But people didn’t pay much into the third pillar because they didn’t have much money. So we needed to make pension saving compulsory,” says Gabriella Béki, pensions spokesperson for the centre-left Alliance of Free Democrats (SZDSZ), the junior coalition partner with the Hungarian Socialist Party (MSZP).
The reform of 1997 introduced compulsory second pillar schemes which were to be funded by diverting an increasing percentage of the employee’s first pillar contribution to the second pillar up to 8%.
After a change of government in 1998, the right wing Young Democrats - Fidesz - decided to address the funding deficit in the first pillar by halting the increase in the diversion of funding to the second pillar at 6% and by also allowing people the option of returning to the first pillar.
However, in the summer of 2002 there was another change of government and the new MSZP-SZDSZ coalition reinstated the increase in funding for the second pillar which rose to 8%, where it stands today.
The plan was to increase the proportion that was to be diverted to the second pillar to 8%. But the result of this diversion of resources was a massive - and growing - funding deficit in the first pillar.
Tamás Katona, permanent undersecretary at the ministry of economics, notes that the deficit in the first pillar stands at between HUF250bn (€1bn) and HUF300bn.
So how to plug the gap? Raise taxes? Borrow more? This matter is an obvious concern. “The government says that the budget deficit is 4.5-4.6% but the EU says it is more than 6%,” says András Csáky, pensions spokesman of the centre-right Hungarian Democratic Forum (MDF). “Some Hungarian economists say that it is as much as 8%. And in order to join the euro the deficit needs to be down to 3% by 2008.”
Katona explains that Brussels has given Hungary some leeway. “For the next five years the EU will not take our budget deficit into account. If we still have a deficit above 3% after that we will negotiate again.”
But he is sanguine: “In 25 years the hole should be filled by taxation.”
The funding problem is also due to the fact that, according to Csáky, some 300,000 people in Hungary receive a pension even though they do not pay pension contributions. “These people avoid contributing, mainly because under the former communist system they were used to getting something for nothing,” he says. “If we got these to pay their contributions we could reduce the contribution. With this in mind we should also broaden the base of wage earners who pay social security contributions.”
Social security contributions are very high in Hungary and are considered an enormous burden on the employer, amounting to some 29% of salary. “Everyone says that the contribution should be cut but nobody says how the shortfall should be made up,” says Csáky. “Then there is the problem at elections that everyone wants to be popular.”
Not only are state pensions in Hungary pitifully low - HUF57,000 per month on average - but the amount one receives depends on the system in force at the time one started contributing. “We want to make sure that the pension people receive is in proportion to their contributions,” says Katona. “This has to be solved; we want to get rid of the old system.”
The government has attempted to address the issue. For a start, it brought in a so-called 13th month pension. “This is welcome but it does not address the inequality in the system,” says Béki.
Csáky shares the concern. “Even though we clearly have to address the fact that pensions are very low the extra month of pension doesn’t relate to anything.”
But the government has addressed the need for a correction. Béki explains that those who became pensioners before 1988 will receive a 4% one-off increase; there will also be an additional 0.5% for each year of service above 30 years. “This correction addresses the problem of inequality of pensions arising from when an individual entered the system,” she says. “So I think this is a good package.”
Prime minister Ferenc Gyurcsány announced the corrective measure last October.
But Csáky is unimpressed: “There is a five-year plan but we don’t like that because it is just a vote winning exercise – and there will probably be a change of government anyway.”
Another issue is that widows and widowers normally receive a part of their deceased spouse’s pension. Until very recently however, if the spouse died more than 10 years before their surviving partner’s own pensionable age there was no pension entitlement.
Katona explains that work has been done on this issue. “A new ruling means that if the surviving spouse fails the 10-year rule and does not automatically qualify they can apply for an exceptional ruling if their financial circumstances are particularly difficult,” he says. “But to lengthen the 10-year rule for everyone would be too costly.”
The other issue is early retirement, and the pressure this puts on the system. In Hungary a high proportion of the population is inactive. This dates back to the switch to a full-market economy at the beginning of the 1990s.
“The prospect of mass unemployment at that time encouraged many who were in their 50s and too old to find new work to take early retirement,” says Béki. “Others tried to register themselves as disabled.”
This situation still exists today, with the result that there are three million people living off state pensions out of a total population of 10.3m.
Furthermore, Csáky notes that until the end of the 1980s the state system produced a surplus. “But these were not set aside,” he says.
As in every country the ageing of the population is a major challenge for the country. “The biggest challenge is to keep the system solvent,” says Béki. “We want to ensure that as few people as possible retire early,” says Katona.
The 1997 reform set in motion an increase in the retirement age for women from 55 to 62, with an increase of one year in the year of the reform and every two years thereafter. The retirement age for men was increased from 60 to 62 with immediate effect.
The life expectancy for a Hungarian male is 63.7 years, says Csáky. “This is the lowest in Europe,” he says. “It is best for the pension system if we retire and die the next day. The social security system does this for real.”
To qualify for a state pension a minimum of 20 years’ service is required. With 38 years’ service, women can take early retirement from 57 and men from 60. From 2009 the early retirement age will be set at 59 for both men and women, but they will have to work 40 years to earn the privilege.
Meanwhile, the problem of the third pillar remains. Their development has been slow because they are voluntary and people still remember their property being nationalised by the communists; this makes it difficult for some to digest the concept of long-term saving.
“We need to encourage long-term thinking even though immediate consumption is more attractive,” says Katona.
The recent change to the payment of tax credits on contributions to third pillar schemes was a bold move. In the past the tax credit - up to 30% of contributions or HUF100,000 - was paid directly to the member at the end of each tax year. From the beginning of this year it will be credited to the pension account.
The tax credit on third pillar contributions is a maximum of 30% of contributions or HUF100,000.
The boldness of the move derives from the attitude of the Hungarians. “People don’t trust the future,” says Csáky. “They want their cash now. So the idea of reinvesting the tax rebate rather than paying it out is not interesting for the average Hungarian.”
In order to further encourage retirement saving the government has launched a so-called ‘fourth pillar’, which like the third pillar is voluntary but is based on investments in the Budapest stock exchange.
But some are skeptical. Béki notes: “I find it very unfair because it will benefit the most rich who can look after themselves anyway.”
Csáky agrees: “The fourth pillar is an extension of the third pillar to help the stock exchange. The population is getting older so on the whole less risky investments are needed. There is only a very small layer of the population which can afford to take such risks.”
He adds: “The basic problem is that the average citizen does not know enough about stocks to do this. They are fearful.”
But Katona is more pragmatic. “We need to encourage saving and this is one way of doing it,” he says. “We think it would be suitable for the middle-aged people and also for middle-income. Furthermore this is new competition for the third pillar.”
Parliamentary elections will take place in Hungary next month. For some time opinion polls have shown MSZP and Fidesz neck and neck. They also show SZDSZ with just 3%, below the 5% minimum required for a seat in parliament, which puts it on the same level as the MDF.