Social security, as a public expenditure, is provided through social insurance - earmarked income, budget transfers regardless of social vulnerability and through social programs for vulnerable families and individuals. Social insurance represents the most widespread form of provision and provision of social security for the population and is financed from contributions paid in varying proportions by insured persons and other persons, most often by their employers. The importance of social security in Montenegro, which is provided through mandatory social insurance, is specifically indicated in Article 67 of the Constitution, which reads:
"Social insurance of employees is mandatory. The state provides material security to a person who is unable to work and has no means of livelihood".
Basic issues of reforms
The system of pension and disability insurance in a large number of countries has, for a long period of time, entered into a financing crisis, which manifests itself through an increase in the difference between dedicated income and materialized rights provided by the state budget. The problem arose due to the increase in the number of pensioners, the decrease in the birth rate and the early realization of the right to pension. The increased number of pensioners influenced the increase in the dependency ratio (the ratio between the number of pensioners and the number of employees), so that the balance in the financing structure of the pension insurance system could be ensured through an increase in contributions for pension and disability insurance. Increasing contributions was not a long-term sustainable strategy, so alternative ways of solving these problems were considered. The functioning of alternative models implied the existence of appropriate investment funds with the task of investing effectively in the long term within developed financial markets. At the same time, this model required solving the problem of financing the pensions of existing pensioners in the period of transition to the accumulation system.
The introduction of investment funds is based on the postulate that the consumption achieved by pensioners in each future year must be made possible by an increase in production in that year. That is, the system of pension and disability insurance can be provided by the current adjustment system and the accumulation system. The current adjustment system is the dominant method that works, provided that the demographic parameters are favorable, that is, if there are favorable proportions between those who pay contributions and those who exercise social security rights. A stable system of generational solidarity requires that paid pensions be equal to the contributions paid by existing employees. The accumulation system partially solves the problems caused by the deterioration of the dependency ratio (the ratio of average pension to average earnings). This system is based on the idea that the funds from the collected contributions are invested in order to generate an appropriate income, through dividends or interest, as a possible source for increasing pensions. When it comes to countries in transition, this problem was tried to be overcome by switching to a pension and disability insurance financing system based on three pillars: a system of a comprehensive public pension and disability system, a system of mandatory pension and disability insurance through privately owned funds - the second pillar, system of voluntary pension and disability insurance - the third pillar.
Announced changes
Systemic changes, which announce the possibility of abolishing/reducing contributions for pension and disability insurance, in addition to jeopardizing the social security of future generations, can further destabilize the fiscal system of the central budget. The fiscal impact of the announced changes has not yet been specified, so the consequences of such a reform solution cannot be clearly seen. Likewise, the goals to be achieved, other than increasing net earnings, are not specified enough. The only thing that is certain is that the generated deficit is planned to be compensated by increasing the value added tax, due to the higher turnover that is expected due to the increase in net earnings.
However, it is necessary to look at the basic fiscal performance of the pension and disability insurance system in Montenegro, in order to be more cautious in entering into strategic systemic measures. According to data from 2023, rights from the pension and disability insurance system were used by an average of 123.723 persons, of which 110.457 persons were pensioners in Montenegro, while the number of beneficiaries of other rights and pensioners outside Montenegro was 13.266 persons. The number of beneficiaries of pension rights in the return for 2019 decreased by 4,54%, while the number of pensioners decreased by 3,72%. At the same time, an increase in the number of employees by 20,1% was registered. In the same comparative period, the collection of contributions for pension and disability insurance increased by 59,94%. More than favorable trends in the field of pension and disability insurance, it is necessary to additionally explain fiscal trends through the reduction of the difference between dedicated revenues and expenditures for the payment of rights from pension and disability insurance in Montenegro. The data clearly show that the deficit of the pension and disability insurance system is decreasing and that the basic criterion of ongoing adjustment, that paid pensions are equal to contributions, is almost fulfilled.
The deficit of the Pension and Disability Insurance Fund was reduced from EUR 91,69 million in 2019 to EUR 27,30 million in 2023. In particular, we should add stable trends in the movement of basic indicators such as the exchange rate and the dependence rate.
The dependency ratio has improved significantly over the past two years, while the replacement ratio has been relatively stable over the past five years.
The dependency ratio was reduced from 0,64 to 0,51, that is, we have one pensioner for every two employees. The decrease in the value of the replacement coefficient from 0,55 to 0,47 indicates a slight deterioration in the ratio of average pension and average earnings. Now the question arises, why is the reform of the fiscally sustainable system through the abolition/reduction of contribution rates for pension and disability insurance necessary? It is more than clear that the replacement coefficient needs to be solved, which requires the activation of the second pillar and the generation of additional income that would enable an increase in the average pension in Montenegro.
Consequences of the solution
First of all, we should take into account the fact that the eventual cancellation of social security contributions may raise the question of the constitutionality of such a solution. In addition, the abolition of contributions for pension and disability insurance or the reduction of rates to a negligible low level means the introduction of the third pillar and the principle of voluntary insurance. The fiscal impact of the possible cancellation of contributions for pension and disability insurance is particularly significant. Using the 2023 budget as an example, it would result in a deficit of 474 million euros, while compensating for the missing amount would require a value-added tax rate higher than 30%.
The situation is further complicated by the social security of future generations and bridging the budget deficit in the transition period. The increase in net income, a motivating factor in the short term, would be replaced by the long-term social insecurity of future generations. In particular, it should be emphasized that the increase in net earnings in the real sector is only for part of the contributions paid by the employee. Part of the contribution paid by the employer would mean an increase in profits, thus further complicating the position of employees and the possibility of using the third pillar as a forced and only possible form of social exclusion. Part of the contributions paid by the employer, as the basis for acquiring the right to a pension, would be permanently lost by the employee. Providing an adequate amount of funds, which would be a function of their social security, would require an additional reduction of the net salary precisely for the part of the contributions paid by the employer.
The executive power has the possibility of direct fiscal intervention through an increase in the value added tax rate (over 30%), which would provide fiscal effects in the state budget in the short term. In the long term, fiscal adjustment could be accompanied by price growth, a real decrease in turnover with an increase in net debt. It is certainly necessary to clearly and accurately plan these indicators due to the seriousness of the systemic measures that are being announced
There is also an important question of the fiscal impact in connection with bridging the deficit in the event that contributions for pension and disability insurance are canceled or reduced to an unacceptably low level. The deficit arises through the influence of two components, the cancellation of contributions for pension and disability insurance on the side of the funding source and the increase in net earnings for part of the contributions paid by the employee. Starting from the execution of the budget for 2023, the canceled contributions and the increase in the net salary of employees in the public sector would increase the deficit by 616,05 million euros, and on the other hand, the deficit would be reduced by contributions paid by employees in the amount of 89,93 million euros and contributions paid by the employer in the amount of 51,29 million. The net effect of the increase in the deficit, on the example of the 2023 budget, would amount to 474,83 million euros, as shown in the following tabular overview:
The executive power has the possibility of direct fiscal intervention through an increase in the value added tax rate (over 30%), which would provide fiscal effects in the state budget in the short term. In the long term, fiscal adjustment could be accompanied by price growth, a real decrease in turnover with an increase in net debt. It is certainly necessary to clearly and accurately plan these indicators due to the seriousness of the systemic measures that are being announced.
The determination that the increased turnover, due to the increased net earnings, would increase the value added tax and thus compensate the deficit in the transition period, contains a risky assumption that the employees will spend their net earnings in their entirety and that they will ignore social security. This concept already implies circumstances in which employees will not use their net earnings for social security?! In that case, the transitional issue of the pension and disability insurance system is reduced to the level of individual responsibility, without state guarantees. Certainly, the problematic construction of fiscal components in connection with covering the deficit remains. Will the multiplier effect of aggregate demand, through an increase in net earnings, affect the increase of the gross domestic product or the deficit of the trade and balance of payments. An increase in imports through the collection of value added tax on imports will have certain fiscal effects. If, in the long term, there is no adequate growth of the gross domestic product, the collection of value added tax in internal traffic will be absent and the issue of the budget result will be further problematic. Caution is more than necessary when making strategic decisions regarding issues of social security for future generations. The intention was not to criticize the announced solution at all costs, but to consider all relevant fiscal components and protect future generations who have the right to a dignified life. Likewise, the views expressed in the text do not represent the views of the Senate of the State Audit Institution, nor the views of the Institution.
The author is a member of the Senate of the State Audit Institution
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