Will our generation ever retire?

Generational contract: employees pay for the pension

The generation contract was introduced in the late 1950s as part of a pension reform. In this guide you will find all the important information about the contract, its origin and its structure in Germany.

What is the generation contract?

The so-called “generation contract” is a fictitious contract that is concluded between two generations. In fact, the generation contract is a social consensus that has not been written down, but is kept by two generations.

The "contract" refers to retirement provision in old age. According to this, the working generation ensures that the pension funds are adequately filled through social security contributions. In the economic sense, the generation contract can also be referred to as a dynamic pension that is financed through a pay-as-you-go system.

Introduced due to lack of funds

In 1957 an extensive pension reform was carried out in the FRG. Up until this year, every employee financed his or her own pension. For this purpose, every employee received a pension account into which he and the employer paid contributions for his pension in equal shares. However, this system had a major disadvantage, as it did not meet the actual needs because the funding was too low.

Eventually, through the introduction of a pay-as-you-go system, another pension system was created, whereby working citizens were supposed to finance the pensions of retired citizens. This so-called “generation contract” goes back to the concept of Wilfried Schreiber. That is why we also speak of the “scribe plan” in this context.

Two- or three-generation contract?

The form of the generation contract originally envisaged by Wilfried Schreiber not only provided that the pay-as-you-go system takes two generations into account. Rather, the children and young people should also benefit from the levy. Accordingly, the two-generation contract would have been a three-generation contract covering childhood / adolescence, employment and old age. In this case, the working generation would create taxes for the pension funds as well as for the offspring.

A concept that takes three generations into account is generally considered fairer as it benefits families with children. In a certain sense, they are the actual bearers of the generation contract, as the children later make contributions to the pension funds. Therefore, children should also benefit from the contributions that their parents make.

With a two-generation contract, the current working population only pays for the older generation and expects the next generation to pay for their pension. Children and young people are not taken into account.

Definitions

The concept of the generation contract is generally understood in its basic principle. However, there are some differences in the interpretation of the name depending on the definition:

  • More general interpretation
    In a broad sense, the generation contract is defined as W. Schreiber intended. Accordingly, a person's income is a lifetime income that is distributed over childhood / youth, working age and retirement age. In this sense, the intergenerational contract offers the possibility of redistributing contributions to children and young people as well as to pensioners.
  • Narrower interpretation
    The German Pension Insurance and the Federal Ministry of Finance only define the generation contract as an unspoken contract that exists between the working population and the pensioners. Those who work pay into the pension fund and thus secure the pension payments to the current pension recipients. Anyone who pays into the pension fund today can expect, in the sense of the solidarity agreement, that the next generation will also pay taxes. A redistribution to children and young people is not envisaged in this concept.

This is how the intergenerational contract works

As already mentioned, the generation contract is not a real contract. There are therefore no written regulations. It is based solely on the consensus that the working generation provides for the pensioner generation through taxes. This principle is anchored in the German pension system.

In practice, employees today pay into the pension fund, which is responsible for the pension payments to the parents and grandparents' generation. With their own work, the employed in turn acquire their own pension entitlements. Your pension will then be borne by the next generation.

Problems and solutions

The so-called intergenerational contract is always controversial. Many critics see it as a term that obscures the actual background. The term “contract” initially suggests that two generations of equal rights would have deliberately agreed on a regulation. In fact, however, no contract was signed and the subsequent contributors had no influence on what happens with their contributions. The generation contract was decided in this way by the pension recipients themselves, who in turn did not make any corresponding contributions to the pension.

Another point of criticism relates to the fact that the pension insurances are said to have not expanded the contributions paid in before the pension reform for provisioning purposes, but rather wasted their assets in many cases.

The criticism that the generation contract originally planned by W. Schreiber was not really implemented is also very serious. In the opinion of these critics, therefore, childless people are preferred because they benefit from the contributions paid by children.

In principle, the question is repeatedly raised as to whether the intergenerational contract is fair at all.

Demographic Imbalance: Impact on the Intergenerational Contract

The generation contract is based on the fact that the contributions of the working generations are sufficient to secure the pension of the older generation. In Germany, however, several demographic factors mean that this balance is becoming increasingly difficult. In short, there are more retirees than workers who pay into the pension fund.

On the one hand, the birth rate in Germany has fallen year on year. At the same time there is the generation of “baby boomers”, those born in the 1950s who reach retirement age. Thus, there are fewer payers who face a greater number of pension recipients. At the same time, as a result of reunification, many workers from the former GDR who had previously paid little or nothing into the pension fund were accepted into the pension system.

As a result of the demographic imbalance, pensions will continue to decline. Anyone who pays into the pension fund today does not therefore know whether they will receive a sufficient pension at all.

Are childless people preferred in the generation contract?

A major criticism of the intergenerational contract is that it gives preference to childless people. You can usually save more money for retirement than families with children. At the same time, these children later pay back into the pension fund, which also benefits childless citizens.

In addition, workers with children are burdened twice by bringing up children and working. If parents can work less because of their children, this double burden can in turn affect the pension, as parents can then acquire fewer pension rights.

This multiple discrimination against parents through the generation contract has already been publicly criticized several times. For example, the former Federal President Roman Herzog and Paul Kirchhof, a former judge at the Federal Constitutional Court, have highlighted this grievance. In the practice of pension distribution, however, nothing has changed to this day.

Is the intergenerational contract in danger?

Not only does demographic development endanger the generation contract, but also the often difficult situation on the labor market. Because ultimately only contributions to the pension insurance can be achieved through jobs subject to social insurance.

In order to save the intergenerational contract, the birth rate in Germany would have to rise significantly again and at the same time the number of jobs subject to social insurance would also have to rise.

It is repeatedly discussed whether all employed persons could be obliged to pay into the pension system. The self-employed would also have to pay into the pension fund, which would bring more money to the pension system overall. In addition, there are considerations which provide for higher taxes for workers with very high incomes. It is also conceivable that childless citizens will have to pay more money into the pension fund than those in employment with children.

Products such as the Riester pension or other state-sponsored projects could also try to compensate for the pension loss through private old-age provision.

possible alternatives

There is no real alternative to the existing generation contract. After all, it is one of the basic principles of solidarity. Statutory health insurance and social insurance are based on a similar principle. However, it is possible to renegotiate the design of the intergenerational contract and include future contributors as well as current contributors in the debate.

Historical development

The basic idea of ​​a social contract that exists between generations goes back to the Age of Enlightenment. At that time, philosophers thought about forms of society that would represent an alternative to the absolutism of manufacturers. The basic idea has always been that the younger generation can support the older generation. The Frenchman Alexis de Tocqueville put forward a very prominent theory in the 19th century with his “contrat social”. In turn, it builds on the ideas of Jean-Jacques Rousseau.

In the 19th century there were finally various considerations in Europe to transfer the generation contract to a sustainable pension system. An important step towards implementation was taken in Germany by Otto von Bismarck, who established the social security system. The idea of ​​the generation contract was already incorporated into a pension system in which the working population was supposed to finance. However, the pension payment was neither guaranteed nor the state replenished the pension fund in the event of missing contributions.

In Germany it was not until 1957 that a pension reform was implemented. A reform was urgently needed, as the pension system applied at the time did not provide any funding for pension payments. The “solidarity contract between the generations” developed by the economic theorist Wilfried Schreiber served as the basis for the reform. In the course of the reform, the pension was established as a dynamic pension based on a pay-as-you-go system.

The unspoken solidarity contract between the generations in Germany still applies today. Those who work and pay social security contributions finance the payments to the current pensioners.