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Chile’s 2008 re-reforms: what are they and what are the implications?

Chile’s 2008 re-reforms: what are they and what are the implications?. By Estelle James, Alejandra Cox Edwards & Augusto Iglesias MRRC Research Workshop, April 2010. Chile is well-known for its 1981 social security reform.

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Chile’s 2008 re-reforms: what are they and what are the implications?

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  1. Chile’s 2008 re-reforms: what are they and what are the implications? By Estelle James, Alejandra Cox Edwards & Augusto Iglesias MRRC Research Workshop, April 2010

  2. Chile is well-known for its 1981 social security reform • Mandatory individual accounts—10% of wagesinvested by private pension companies • Pre-funded, so avoids implicit pension debt • Benefit depends on contributions + investment earnings so reduces implicit payroll tax and encourages work • Tax-financed public pillar: • Min. pension guarantee (MPG) for contributors, • means-tested social assistance (PASIS—12% av. wage) for those with no other retirement income

  3. High returns but problems developed • Close linkage between benefits and contributions meant that those who didn’t contribute much got little if any pension. • Studies showed low contribution density—typical for low and middle-income countries. Many workers self-employed or informal—contributions not required or enforced • Special problems for women because of their low lfpr and wages—their benefits 1/3 males’

  4. Remedies in 1981 system • MPG and PASIS provided public safety net • Survivors benefits and joint annuities covered married women (keep own+joint). • But: • MPG didn’t help those with < 20 years of contributions & posed work disincentives once 20 year eligibility was met • PASIS had long waiting list and low pension • Women had lower D&S rates than men, but paid same insurance fees (as % of W) • In 2006 presidential candidate Bachelet promised to solve these problems, help women

  5. 2008 reform • Some expected elimination of IA system but this didn’t happen • Instead, tax-financed public benefits expanded, replaced MPG & PASIS, reach 2/3 elderly • Incentives to contribute to IAs also increased • New policies designed to help women • What is the impact on pension distribution, work incentives, fiscal costs, system sustainability? We use CASEN 2006 data and simulations

  6. Main change--larger public benefit • New flat basic benefit for elderly with no own-pension (19% av. wage)—replaces PASIS • Phased out at 29.4% rate against person’s pvt pension, =0 when pvt pension=$425 (65% av w) • No contributory requirement; replaces MPG • These benefits go only to elderly in bottom 60% of households—almost all in bottom 60% get some public benefit • Most elderly in top 40% have private pensions < $425 but get no public benefit 6

  7. Basic benefit = CH$75,000 if private pension = 0 APS = supplemental pension = basic benefit - .294 private pension PAF = private pension Total pension = basic benefit or (APS + private pension)

  8. Measures to increase contributions • Contributions mandatory for some self-employed • Contributions subsidized for young low earners • Private pension is only benefit for top 2 quintiles and for retirees < 60W/65M • But public benefit is more than half total pension for bottom 3 quintiles >60/65

  9. Policies designed to help women • Major beneficiaries of new public benefits, espec. basic benefit for noncontributors • Rebate for D&S insurance into their accounts • New baby bonus into pension account • Still benefit from survivors insurance + joint annuity • Still can start public + private pension at 60 instead of 65 like men—missed opportunity for trade-off

  10. Some impacts consistent with goals • Increases pension coverage in bottom 60%; also raises av. pension amount • Lowers coverage and av. pension for top 40% • Large redistribution to bottom 60% of hh, to noncontributors and women • Decreases elderly poverty, but little impact on poverty over-all (would transfers to young families be more equitable?) • Provides insurance against financial market risks and longevity growth

  11. But some potential impacts are problematic • Disincentive for formal work and contributions • Long run fiscal costs may be high • Retirement age for men and women too low • Dividing line between top 2 and bottom 3 quintiles ambiguous

  12. Impact on contributions • Non-contributors get much larger public benefit than before • Private pension faces 29.4 % implicit tax in bottom 3 quintiles (Negative impact of MPG was concentrated in much smaller group) • Inc and subst effect might discourage work, encourage self-employment and informality • Pure flat ben would have avoided disincentive • High-income countries with phased-out flat benefit have greater enforcement /collection capacity, less danger of informality

  13. Fiscal impact • Ministry of Finance did not make fiscal projections until after law was passed, did not spell out assumptions, no sensitivity analysis • Expected fiscal impact small (1% GDP 2020) • But costs could rise in long run due to policy and behavioral changes: if • wage indexation replaces price indexation • more elderly shift to bottom 3 quintiles • public benefits extended to top 2 quintiles • contributions fall due to disincentives • population ages due to longevity growth • Our simulations show that fiscal cost in 2050 could be 3-4% GDP or 8% of wages (in addition to 13% of wages for private accounts, admin costs and D&S insurance).

  14. Estimated fiscal costs of Chile’s new public pillar (as % of GDP) Source: Authors’ calculations based on estimates of numbers of PBS and APS old age recipients in bottom 6 deciles of households, using 2006 CASEN data up-dated to 2008 $s

  15. Lost opportunity to link starting age to longevity and equalize for M&W • Women can start their pensions at 60, men 65 • If start of private pension were delayed to 65, it would increase by 50%--greater gender equality & potential output, smaller pub. ben. • If public pension were delayed to 65, this would save treasury money • But age 60 was retained for women • Tax burden will grow as longevity increases unless starting age for public pension is linked to life expectancy

  16. Conclusions • Increased coverage to virtually 100% • Exclusion of top 2 quintiles and phase-out of public benefit designed to save fiscal costs • Will private pensions decline as more workers become informal due to new implicit tax? • Will work by women be discouraged? • Can mandate for self-employed be enforced? • Will fiscal costs rise due to wage indexation, extension of public benefits to top 40%? • Cost trade-off could be improved if starting age were linked to longevity, same for W&M • Economic sustainability unclear but political acceptance by broad l-r coalition increased

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