In the middle of April, the Bulgarian media reported the emergence of a new social security policy idea.

The idea, authored by the lead partner in the country’s tripartite coalition, the Bulgarian Socialist Party (BSP), foresees a change in the formula for calculating pensions. Under the existing Social Security Code (SSC), the size of new pensions is calculated according to a formula that binds length of service, during which social security contributions were paid, and the size of average social security income to the individual social security income in the country. Each year in employment equals one per cent of the average social security income for third-category labour. This means that if a person has accumulated a 40-year work record and has an average social security income throughout the social security period equal to the average social security income in the country, then on retirement, the recipient will get a pension amounting to 40 per cent of the average social security income in the country for the past 12 months.

The BSP proposes to increase the coefficient, which binds each year of service with the size of the pension, from one per cent to between 1.05 per cent and 1.2 per cent. In reality, this means that the person in the example given will get a pension ranging between 42 per cent and 48 per cent of the size of average income in Bulgaria, depending on the coefficient used.

According to media calculations, this move would on average result in 500 million leva a year in pension spending. Against the background of the expected billion-leva budget surplus this year, the above figure does not seem untenable for the budget. However, it is the financial volatility of the pension insurance system in the long run, and even the medium run, that the Government is trying to hide. In other words, in the next few years the social security system will dip so much “in the red” that the volume of governmental subsidies necessary to cover the Pension Fund deficits would become untenable for the budget. This means that the future pensioners will not get the pensions they were promised. Without the changes, the Pension Fund gap in 2008 will total two billion leva, about three per cent of GDP.

Alongside the re-calculation of pensions, the BSP plans an additional pension increase, which would come as an increment to the 9.5 per cent increase as of July 1 entered in the state budget. The preferred option now is a 10.35 per cent hike with an option for additional increase as of October. This would not serve as a precedent because last year saw such policy-making: instead of a 8.5 per cent raise, pensions were increased by 21 per cent by the end of the year. This, however, strips the basic rule (the “Golden Swiss rule”), which sees pensions indexation 50 per cent based on the increase of social security income and 50 per cent based on consumer prices for the previous year.

The national pension system, which pays tribute to solidarity between generations and re-distributes income through the state budget (Bulgaria’s first pension capitalisation pillar), generates implicit (hidden) state debt. Even though it is not present in the official balance statement of the country, it in fact exists, and once the inevitable pension reform and the potential transition to the capital formation pension system occurs, this debt will surface as explicit state debt. As of the end of 2006, the implicit pension debt totalled 202 per cent of GDP (using the seven per cent discount rate). The increase of the coefficient on each year of employment to 1.2 per cent would lead to implicit debt tantamount to 235 per cent of GDP.

It is true that income of existing pensioners is too low to allow decent sustenance. However, pension policy making needs to account not only for short-term effects geared by populist goals, but also must make an objective analysis of the economic impact in the long run, long past elections or the end of this Government’s term. For this reason, the increase of pensions for existing retirees needs to run alongside systemic reform that entails the transition to the capital pension system to ensure decent income for the old-age generation in several decades. Each delay of reform, in turn, will cost more to the young and future generations, which are to bear the burden of the implicit pension debt.