Health Care, Elderly Entitlements Create Large Unfunded Liabilities in Europe

NCPA Study: Shrinking Population Growth Means Higher Taxes, Fewer Benefits or Both

DALLAS (January 22, 2009)- Commitments to universal health care plus retirement benefits for the elderly have put European countries on an unsustainable course, according to a new study from the National Center for Policy Analysis (NCPA). Matters are made worse by low birth rates coupled with a record number of baby boomers entering retirement and receiving benefits.

"Europe is headed toward generational warfare," said Jagadeesh Gokhale, author of the study. "Paying benefits already promised means ever-increasing taxes on younger workers. But keeping taxes at current levels will require continued benefit cuts for retirees."

Many European countries are undergoing rapid population aging as women have fewer children and senior citizens live longer. This means the number of retirees per worker will continue to grow.

In order for Europe to replace its population, the fertility rate needs to be 2.1 births per woman of child-bearing age, said Gokhale, who is a senior fellow at the Cato Institute.  However, fertility rates in European countries range from a low of 1.2 to a high of 1.9. This implies that the population of every European country eventually will peak and then start shrinking.

As in the U.S., most of Europe's health and pension expenses for the elderly are funded on a pay-as-you-go basis. That means no resources are set aside and invested each year in order to pay future expenses. As a result, all European countries have large unfunded liabilities - the difference between the projected cost of government social welfare programs and expected tax revenues. The cash flow problem created by these liabilities will grow over time.

In order to pay benefits without raising taxes, according to the study, the average European country would need more than four times the amount of its GDP invested, earning interest.

"Tax rates will have to continually rise through time to pay promised benefits," said Gokhale. "For example, unless there is major reform, the average European country's tax rate will have to be at 60 percent of national income by 2050 to meet its obligations."

Some countries are encouraging or requiring workers and their employers to save and invest in funds that will replace taxpayer obligations. "England has been doing this for years," said Gokhale, "and over the past decade Sweden, Poland, Latvia, Estonia, and Lithuania also have moved to pre-fund elderly retirement benefits with privately funded accounts."