Navigating demographic challenges: The impact of increasing social contribution rates on tax revenue and distribution

Abstract

The demographic transition poses significant fiscal challenges to pay-as-you-go social security systems, particularly in ageing societies like Germany. While extensive research has analyzed the direct effects of demographic change on rising contribution rates, the secondary effects of the income tax system that arise from the deductibility of contributions have received little attention. This study addresses this gap by examining how the tax treatment of social security contributions influences distribution of the demographic burden. Based on detailed microdata from the German Income and Expenditure Survey (EVS) and official income tax statistics, we apply a generational accounting framework to analyze intergenerational redistribution effects. As a secondary finding, we also identify intragenerational redistribution resulting from the tax deductibility of proportional social security contributions under a progressive income tax schedule. Our findings reveal that future generations are disproportionately affected by declining income tax revenues, while current generations benefit from an average tax relief of 47 percent. Moreover, a regressive burden distribution is indicated: individuals in the lowest income quintile face an effective burden of 91 percent, as compared to 62 percent in the top quintile. These results underscore the importance of accounting for indirect tax effects when evaluating the long-term sustainability and equity of social insurance reforms.