The main principle underlying the pay-as-you-go or PAYGO system is that incoming money is not stockpiled but is immediately paid out. The earning power of those in paid occupations thus finances the benefits paid to those who are in retirement in the same period. For this reason, this system is sometimes referred to as a “cross-generational pact”, although it is not the actual generations (number of people in specific age groups) that are relevant, but their earning power and the contributions they can afford. A very few individuals who have very high incomes can afford to pay more into the system than a much larger group of persons with low or no incomes, whereby it is not only the contributions and taxes deducted directly from income that play a role, but also those contributions that are paid indirectly that are important (such as VAT). The latter help the state maintain and secure social standards (e.g. VAT contributions are used to finance health centres and the health and social benefits provided through the GSBG).
The PAYGO system thus bypasses many of the risks associated with investment. Factors such as Inflation, collapse of share prices and devaluation of investments as a result of poor management (cf. the raiding of pension funds by Maxwell, Enron in 2001 and Orange County in 1994 etc.) thus represent less of a threat to this system in comparison with other systems. And, unless the relevant legislation is put in place, it is not easy to redirect the collected funds into other channels (for the financing of other objectives etc.). The capital thus continues to circulate within the financial sector from which it originates. The system itself furthers the maintenance of this internal cycle.
However, problems can arise if the amount of the benefits paid out (in the form of pensions etc.) is subject to unexpected peaks (due to factors such an increase in the number of persons taking early retirement), the number of contributors falls or doubt arises as to the willingness of the state to continue to provide financial input to the system. The risk is then that the liquidity of the system will suffer. The system is linked to the economic cycle so that in periods of high unemployment, for example, contribution income will be lower and persons in receipt of a state pension will experience drawbacks, and may have to do without pension increases. Despite this, the system is better placed to accommodate such economic fluctuations as the “insurance risk” is spread across a very wide section of the whole population, thus providing for greater safeguards. The fact that the state is involved also means that it is possible to fully or partially exempt individuals from making contributions in periods in which they are not financially in a position to make provision for their old age, such as periods in which they are involved in childcare, unemployed, ill or in national service. (cf. Arts. 227 ff. of the ASVG).
The PAYGO system (concurrent collection and expenditure) is the system that is most appropriate for larger economic entities. Neither large corporations nor the state are in the position in which they can “save” the money they need to cover their outgoings over the long term. Of course, every system provides for the retention of (relatively) small reserves to cover any temporary financial need, but it is the fact that the budget is balanced rather than the size of this reserve that will determine the success or otherwise of such large organisations.
The value of the PAYGO system becomes apparent when it is necessary to secure the financial situation of wide sections of the population of a country as this system is better able to cope with income fluctuations as a result of the large number of persons involved. The PAYGO system is less advantageous to persons on very high incomes and for this reason contributions (and also benefits) are capped. No contributions are paid from income above this threshold, and thus a higher income has no influence on the amount of benefit. Persons in this situation who wish to maintain their standard of living into old age will need to make additional arrangements (private pension, life assurance etc.). In recent years, just over 10% of those in paid occupations had an income that was above the maximum contributory basis.
Capital cover system
An alternative funding method is the capital cover system. The fundamental concept here is that everyone is responsible for themselves (and their family) and saves towards their retirement. The advantages and disadvantages of this system are the converse of those of the PAYGO system: there is considerably more investment-related risk, but the economic situation of the state as a whole has less influence – that is, assuming that investors are able to arrange their pension investments so that they are not significantly affected by factors such as inflation and currency exchange rate fluctuations, and that they can continue to put sufficient money aside during periods in which their income is low (as a result of sickness, unemployment etc.). The risk of loss of liquidity also applies in the case of this form of funding: the apparently best forms of investment (gold, shares, property) are not necessarily those that can be most rapidly converted into cash and their value can go down as well as up. Their value is dependent on the demand at the time at which they are being offered for sale, and this can be very low in periods of economic instability. If it is necessary to sell rapidly in order to acquire larger amounts of cash, the return can be poor. Negative economic developments can have a far greater knock-on effect in the capital cover system (although investment decisions also play a role) than in the PAYGO system (cf. the arguments below). However, the capital cover system does provide the chance of making considerable gains, assuming there is the willingness to assume the corresponding risk. It will always be necessary to weigh potential profits against the potential risk.
The question of which system should be preferred is the subject of on-going debate. The PAYGO system requires no saving of capital and is thus more flexible if the need for modification arises than the capital cover system that relies on savings and reserves. Austria’s own experience with the PAYGO system has been positive and the state sees no reason to discard it. Adjustment to economic changes will be necessary whatever system is employed; this is an inherent problem when it comes to investment and providing security for the future. Under the PAYGO system, individuals are exposed to less risk; they are not faced with a problem if they do not have sufficient income to fund their pension or health insurance over the long term. Austrian citizens in receipt of an Austrian state pension living in Austria, an EU country or a country with which Austria has an agreement are automatically provided with the statutory health insurance cover.
The level of protection that can be provided through legislation is more or less the same in both systems. Legislation can be used to intervene in the operation of the PAYGO system just as it can be used to directly or indirectly modify the private arrangements of the capital cover system (e.g. by changing the regulations relating to savings, tax exemption limits or even by directly revising contract law – cf. the provisions of the Versicherungswiederaufbaugesetz [pension reform law] in BGBl. No. 185/1955, Arts. 6, 12, 14 and 16 and the related article on page 491 of the 1989 issue of “Soziale Sicherheit”; for recent years, see Art. 273, section 13 of the GSVG: Law on statutory insurance for persons working in commerce and industry).
Economic crises will have an effect not only on the contributions collected under the PAYGO system but also on the security of investments and reserves under the capital cover system. The fact that the risk is spread widely (large community of insured persons) and there is little investment-related risk means that that the PAYGO system has certain advantages. Of course, the system does need to be continuously reviewed and modified to changing requirements, but as it protects the interests of insured persons it would not be appropriate to abandon it offhand. Because of the large number of participants and the involvement of major institutions (insured persons, contributors, employers and state), the administration costs are shared by the many, while synergy effects (e.g. the system can be used for the collection of other statutory payments, such as taxes, levies and housing construction subsidies) can be exploited to keep administration expenses down.