Growth effects of changes in social security contribution rates in Germany

The German economy has been in stagnation for some time while the government is faced with high and rising costs of the social security system, defence and interest on debt. Structural reforms are needed to stabilize the social system and to strengthen potential growth. The recent reform package proposed by the German Pensions Commission represents an important step forward. Among other changes, it introduces a capital-funded element, which will help stabilize the existing pay-as-you-go statutory pension system. However, this will be financed by an increase of social security contributions on the order of 2 percentage points, which will dampen economic growth. According to our analysis using a large-scale structural macro model, the increase in contribution rates raises the cost of labour and may reduce GDP all else equal by approximately 0.6 percent in the medium term. The three economies in the model are calibrated to Germany, the rest of the euro area and the rest of the world. Spillover effects to the rest of the euro area remain very small. Our findings should not be understood as an argument against the much-needed pension reform, but should rather be taken to further strengthen the case for additional growth-oriented supply-side reforms.