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A further indicator to illustrate the budgetary consequences of ageing is the required primary balance (RPB), which is derived under the assumption that the intertemporal budget constraint of the government is respected over an infinite horizon (i.e. by eliminating the S2 sustainability gap indicator). It is defined as the primary balance that is sufficient to stabilise debt and to finance the increase in age-related expenditure. It is a more stable indicator than the corresponding S2 gap indicator. The RPB as well as the structural primary balances are shown in Table I.4.5.

The RPB varies widely across Member States, ranging from almost 10% of GDP to below zero, which mainly reflects the large dispersion of the projected changes in age-related expenditure.

4.5. QUALITATIVE CONSIDERATIONS

In order to arrive at a comprehensive assessment of the long-term sustainability of public finances, additional factors are taken into account in order to better qualify the quantitative assessment. Adding qualitative factors may lead to a different overall assessment than the one that would result from the sustainability indicators only.

The current level of the debt-to-GDP ratio is arguably the most important additional factor. While the sustainability indicators already include information on the current level of debt, (1_{) they do not incorporate all the specific}

risks faced by countries with a large initial level of debt. First, high-debt countries are more sensitive to short to medium-term shocks to

(1_{) The contribution of the debt to the S2 sustainability}

indicator for a country with a debt/GDP ratio of 100% and an interest/growth rate differential of 1.5% is in fact 1.5% of GDP (debt times the interest/growth rate differential).

economic growth and interest rates. Second, a high level of debt may lead to higher interest

Table I.4.5: Structural primary balance Increase in age- related expenditure Required primary balance 2007 between 2010 and 2050 BE 3.5 6.6 6.3 BG (2₎ 4.1 0.1 0.1 CZ -3.0 7.7 5.7 DK 4.9 1.2 1.7 DE 2.5 4.0 4.4 EE 1.3 -1.8 -0.7 IE 1.4 7.8 5.9 EL (1_{) 1.1 1.4 2.6} ES 3.8 8.9 6.6 FR 0.6 3.2 3.4 IT 2.7 2.3 3.8 CY 5.0 11.7 8.9 LV -0.1 1.6 1.8 LT -0.4 2.1 2.0 LU 0.9 8.4 8.5 HU -0.8 6.9 6.3 MT 1.2 -0.6 0.2 NL 1.8 5.2 5.2 AT 2.0 1.1 2.5 PL -0.2 -3.2 -0.2 PT 0.8 4.9 4.2 RO (2₎ -2.5 -1.1 -0.5 SI 0.5 9.9 7.3 SK -1.5 3.7 3.2 FI 5.7 5.0 4.8 SE 4.0 2.4 2.9 UK -0.8 4.2 3.9

Source: Commission services.

Required primary balance (% of GDP)

Notes: The required primary balance is given as an average over the period covering the first five years after the last year covered by the programme. (1_{) No pension projections were available for Greece and the rise in age-related} expenditure is therefore underestimated. Pension expenditure was projected to rise between 2005 and 2050 by 10.2% in the 2002 update of the Greek stability programme.

(2_{) No commonly agreed long-term projections available.}

than assumed in the projections and increase further the risks to sustainability. Third, when calculating the sustainability indicators, it is assumed that all countries can keep their current primary balance constant as a share of GDP. High-debt countries need to maintain large primary surpluses for a prolonged period of time in order to reduce the level of debt. This may prove difficult. This factor is used symmetrically as a risk-increasing factor for very high-debt countries, such as Belgium, Greece and Italy and a risk-decreasing factor for very low-debt countries or countries with large financial assets in reserves for the payment of future public

pension, such as Finland, Ireland, Luxemburg and Sweden (1_).

The sustainability indicator in the '2007 scenario' is based on the budgetary projection for 2007 in the SCPs, corrected by the effects of the business cycle and possible one-off and temporary measures so as to capture the underlying

structural budgetary position, which is then assumed constant in a 'no-policy-change' scenario. The budgetary position may nonetheless change significantly in the short term, e.g. because some already enacted measures will gradually impact on the budget. The Commission services' forecasts are made under the assumption of unchanged policies and can indicate such short-term trends. If significant, such trends may nuance the assessment that could be inferred from the '2007 scenario'. In the cases of Ireland and Spain, the decline in the structural budget balance until 2009 as planned by the latest programme updates is also projected by the Commission services' autumn 2007 forecast (available at the time of the assessment), which would give additional plausibility to the less favourable sustainability projection in the 'programme scenario' (2_).

As the sustainability indicators are calculated on the basis of the projections of the Ageing Report (2006), unless a peer review in the EPC has taken place, pension reforms (or reform plans) are therefore considered as additional factors. The influence on the assessment of a pension reform depends on a number of factors: specifically whether the reform has been enacted or not, whether the reform is deficit-increasing or deficit-decreasing and whether the budgetary impact of the reform is available or not. Enacted reforms are taken into account in the risk assessment. However, a certain degree of caution is necessary as the information provided on the reform and its budgetary impact may not

(1_{) The assets considered in the analysis are financial assets}

on a consolidated basis (i.e. holdings of government debt are netted out). They exclude: (1) assets of mandatory funded schemes and occupational schemes, which are classified outside the general government sector; (2) non- financial assets.

(2_{) In the updated programme of Ireland, the budgetary}

projections for 2009 and 2010 explicitly incorporate unallocated contingency provisions of, respectively, 0.4% and 0.8% of GDP.

correspond to the methods agreed by the EPC. Implemented, deficit-decreasing reforms were taken into account for Germany and Hungary (in addition to the EPC-peer review). By contrast, deficit-increasing reform plans, as well as failure to implement a previously enacted reform, may be considered as an additional risk factor. Austria, Estonia, Latvia, Malta, Poland and the United Kingdom have introduced reforms (or plan to do so) to their public pension systems aiming at ensuring adequate pensions in the future. Cyprus, the Czech Republic, Finland, France, Italy, Lithuania and Spain have enacted or are considering reforms, where the progress of implementation or the information given in the SCPs was not sufficient to arrive at a qualitative assessment.

Further aspects of the pension system that are not captured by the sustainability indicators are also taken into account. In particular, the calculation of the sustainability indicators is based on gross pension expenditure. For Denmark, Hungary and the Netherlands rising revenues from the taxation of public but also private pension schemes would reduce the sustainability gaps (3_{). In Hungary,}

however, the future tax treatment of pensions is not fully fixed yet, and further changes to the pension formula may become necessary.

The reliability of projections may play a role,

particularly when long-term assumptions/projections are considerably different from the common budgetary projections in the Ageing Report, suggesting that the indicators may be over- or underestimated. This applies to Bulgaria and Romania, for which in view of their recent accession long-term projections were not included in the Ageing Report. In fact, the lack of comparable and comprehensive long-term projections for these countries prevents the Commission from reaching an overall assessment for these countries. Nonetheless, a significant impact of ageing on government expenditure cannot be

(3_{) In Hungary, new pensions awarded from 2013 onwards}

will be subject to income tax, instead of being tax exempt. According to the Hungarian authorities, direct taxes paid by pensioners will amount to 3.6% of GDP in 2050. This reduces the S2 sustainability indicator by 2.8% of GDP, reaching 4.1% of GDP in the '2007' scenario'.

excluded given the current and projected demographic structure. Moreover, missing projections, in particular for Greece (pension and long-term care), result in a clear underestimation of the long-term budgetary impact of ageing. Greece was in fact invited by the Council to produce pension projections as soon as possible. Projections for long-term care are also missing for Cyprus.

The SCPs may provide alternative projections to those of the Ageing Report (2006), even in absence of (pension) reforms, for example by updating demographic trends. The existence of alternative projections is mentioned in the additional factors. However, for the sake of comparability between countries and for the transparency of the assessment, the overall assessment is made on the basis of the methodology and assumptions of the Ageing Report.

Furthermore, decreases in the benefit ratio larger than 20% over the next 50 years are included in the qualitative assessment (1_{). This is based on}

the analysis of the Commission's Sustainability Report (2006). The general framework for assessing the 'sustainability' of the change in the benefit ratio is theoretically well understood: a decrease in the (public) benefit ratio may not raise pressure to increase public spending if current savings in private supplementary pensions are sufficient, if the financial incentives to work longer are large enough and if there is no obstacle to the work of older workers. Yet those factors are difficult to assess in a cross-country analysis. Therefore, the benefit ratio is taken to inform about possible additional risks. Examples where the benefit ratio entered the qualitative assessment are Austria, France, Germany, Italy, Poland, Portugal, Slovakia and Sweden.

The tax ratio could also play a role. Indeed, it may be more difficult for high tax-ratio countries to increase taxes further, limiting the possibilities to deal with the budgetary impact of an ageing population. This could be the case for high-tax countries such as Belgium, Sweden and Denmark, should the need arise.

(1_{) Ratio between the average pension and the GDP per}

worker.

Measures with large intertemporal effects on the budget are mentioned in the sustainability assessment, whether or not they are treated as one-offs for the purposes of calculating the structural balance that is relevant for the SGP procedure. An example of this is the severance pay (TFR) in Italy.

4.6. OVERALL ASSESSMENT OF THE