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1.3.
Methods of financing social security
There is some variation between the countries as far as methods of financing social secu-
rity are concerned, but all 8 countries are using a mix of social contributions and general
taxes.
In Sweden the major part of social security is financed by contributions paid by the
employer, but a gradual change is taking place, where contributions from the employees
are increased and those paid by employers decreased. In Germany social security is also
mainly financed by contributions, equally shared by employers and employees. By far the
major part of the Austrian benefit schemes is financed by contributions, but the minimum
pensions are financed from general taxation. Minimum pensions, however, only constitute
a minor share of the total expenditures for pensions in Austria. In the Netherlands the
general system is financed by taxes (social contributions are incorporated in the first tax
bracket), the separate one for employees by contributions paid by employers and em-
ployees. A reform in 1990 in the Netherlands partly shifted the payment of contributions
for general social security from the employer to the employees. In recent years Dutch
employers have taken over the sickness benefit scheme and are now sole contributors to
the disability pensions schemes. In Great Britain the component of the system for people
working is financed by contributions paid by the employer and the employees, while the
component for other groups in the population is financed by taxes. Finland also has a
mixed system for financing the social security system. Several of the Finnish schemes, e.g.
unemployment insurance and retirement insurance are financed by a mix of social contri-
butions paid by the employer and/or the employee and general taxes. In Denmark the
general method of financing has mainly been by taxes. From 1994 a social contribution
paid by the employees has been introduced as part of a new taxation scheme, in 1997 the
contribution was 8 per cent of earned income (not including transfers) and there is no
ceiling. The new social contribution is financing unemployment benefits, the early retire-
ment scheme, illness benefits and labour market activities. The Danish change may be
more formal than real. In Canada three of the schemes, illness, unemployment and mater-
nity leave benefits belong to the Employment Insurance scheme, which is financed by con-
tributions just as the supplementary pension scheme. Basic pensions and family allowances
are tax financed. Compensation for injuries from work are financed by contributions from
employers.
Again, the categorization according to methods of finance is crude.
Table 1.3 shows the variation between the 8 countries.
As can be seen from the table, the characterization is not clear-cut, very often the financing
is a mix of general taxes (or budget deficit) and social security contributions. The ’ratio’
between the two methods depends on the business cycle. In a recession a larger part is fi-
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Table 1.3.
Methods of financing social security, 1997.
Elements
DK
S
FIN
A
D
NL
GB
CAN
Illness benefits, insurance
2
2
2
2
2
2
2
2
3)
Unemployment, insurance
2
2
2
2
2
2
2
2
1)
Injured from work, insurance
2
2
2
2
2
*
2
Disability pension
*
2
2
2
2
2
2
2
Retirement
*
2
2
2
2
*
2
*
/
2
2)
Family allowance
*
*
*
*
*
*
*
*
Maternity leave, benefits
2
2
2
2
2
2
2
2
3)
*
Primarily financed by general taxes.
2
Primarily financed by contributions from employer and/or employee.
1)
In recent years a substantial part of the expenditures has been financed by loans for the funds in charge
of the system.
2)
In the Netherlands, itemized parts of the first tax bracket finance the public old age pension system.
3)
The employers are entirely in charge of these schemes from 1996.
nanced by taxes or budget deficits, e.g. the unemployment insurance in Sweden and
Germany has been supplemented by ’deficit’ financing in recent years.
The proportion of social contributions paid by the employer and the employees may
change over time. In e.g. Sweden the social security contributions paid by the employer
have, as already mentioned, been lowered in recent years, in order to reduce the labour
costs. There has been a parallel increase in the employee paid contributions in Sweden
since their introduction in 1993, a tendency which is expected to continue during the
introduction of the new public pension scheme, cf. chapter 2. Denmark has very small
employer paid contributions.
According to economic theory, there is hardly any difference, at least not in the long run,
between financing through taxation and contributions, the employees will pay for social
security anyhow. Financing by contributions may, however, imply a higher degree of
transparency, if the contributions reflect the costs of the scheme.
The schemes characterized by contributions paid by the employers and/or the employees
and with benefits related to income, are often regarded as more ’insurance like’ than other
schemes. However, almost all elements of the public social security systems are ’pay as
you go’ schemes, and there is no actuarial connection between the contributions paid and
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the benefits received. The Danish supplementary pension scheme (ATP) is probably
closest to being an ’insurance’ system. It is a ’defined contribution plan’ with an actuarial
link between the contributions and the benefits.
In systems based upon contributions, entitlement for benefits is often conditional on
having paid contributions, but not always. In Sweden e.g. there is a general entitlement for
the basic old age pension also for people who have never been employed or self-employed.
Denmark represents the ’opposite’ case. As already mentioned, unemployment insurance
is (from January 1994) basically financed by contributions paid by the employee and self-
employed, but in order to be eligible for the benefit the employee and self-employed also
has to be a member of the insurance system (and pay a special fee for the membership).
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