Social Security Programs and Retirement Around the World: Fiscal Implications of Reform

Social Security Programs and Retirement Around the World: Fiscal Implications of Reform

by Jonathan Gruber
     
 

The future of Social Security is troubled, both in the United States and in most other developed countries with aging populations. As improvements in health care and changes in life styles enable retirees to live longer than ever before, the stress on national budgets will increase substantially. In Social Security Programs and Retirement around the World,

Overview

The future of Social Security is troubled, both in the United States and in most other developed countries with aging populations. As improvements in health care and changes in life styles enable retirees to live longer than ever before, the stress on national budgets will increase substantially. In Social Security Programs and Retirement around the World, Jonathan Gruber, David A. Wise, and experts in many countries examine the consequences of reforming retirement benefits in a dozen nations.

Drawing on the work of an international group of noted economists, the editors argue that social security programs provide strong incentives for workers to leave the labor force by retiring and taking the benefits to which they are entitled. By penalizing work, social security systems magnify the increased financial burden caused by aging populations, thus contributing to the insolvency of the system.  This book is a model of comparative analysis that evaluates the effects of illustrative policies for countries facing the impending rapid growth of social security benefits. Its insights will help inform one of the most pressing debates.

Editorial Reviews

Journal of Pension Economics and Finance

"Like its predecessor NBER volumes from this project, the new book is informative and useful as a reference for social security schemes and looming problems in the covered countries."

— Monika Buetler

Journal of Pension Economics and Finance - Monika Buetler

"Like its predecessor NBER volumes from this project, the new book is informative and useful as a reference for social security schemes and looming problems in the covered countries."

Product Details

ISBN-13:
9780226310176
Publisher:
University of Chicago Press
Publication date:
10/28/2007
Series:
National Bureau of Economic Research Conference Report Series
Pages:
392
Product dimensions:
6.00(w) x 9.00(h) x 1.40(d)

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Social Security Programs and Retirement around the World Fiscal Implications of Reform
The University of Chicago Press Copyright © 2007 National Bureau of Economic Research
All right reserved.

ISBN: 978-0-226-31017-6



Chapter One Microsimulation of Social Security Reforms in Belgium

Raphael Desmet, Alain Jousten, Sergio Perelman, and Pierre Pestieau

1.1 Introduction

The various Belgian social security schemes are facing an uncertain future. The general trend toward demographic aging across all of the developed world and large parts of the developing world has not left Belgium unaffected. Demographic aging is the result of a combination of two trends. First, there has been a substantial decrease in fertility rates of women over the last few decades. Second, we have observed a strong increase in life expectancy across most categories in the population. Unfortunately, these trends have a strongly negative financial impact on a variety of social insurance and social protection programs, ranging from child support payments, the health care sector, to questions of retirement income and long-term care arrangements. While the problem can be approached in a myriad of ways, we approach it from the perspective of the social security system, thus largely leaving aside the question of health care and long-term care costs. While it is true that this focus inhibits a truly global view of the financial consequences of aging for government budgets, it is also true that introducing them would cause tremendous problems in terms of modeling the evolution of health care costs, as well as in terms of a loss of international comparability.

For the social security systems to survive this demographic process, higher contribution levels and/or lower benefits will have to be introduced, given the outright pay-as-you-go (PAYG) nature of these systems. Indeed, a straight increase in the public debt financing of the demographic transition is not truly an option in Belgium, as it would be totally incompatible with the Maastricht criterion of the European Economic Monetary Union (EMU) relating to the level of GDP. But even beyond this purely institutional limit, a further increase in public debt levels is also financially unsustainable, as it would quickly cause a snowball effect like the one observed in Belgium in the 1980s.

Leaving aside these purely demographic considerations, other factors are challenging the way the Belgian social security institutions and systems are organized. First, there is the potential for increased labor mobility. At present, mobility between jobs in the public sector, the private sector, and in self-employment is rather limited, at least partly because of the way the three systems work. The needs of the labor market of the future, with its increased degree of flexibility, may thus induce large changes in the way the three corresponding social security systems work. International job mobility is also becoming more and more important, particularly for a small, open economy in the heart of Europe like Belgium. Jousten and Pestieau (2002) argue that both levels of intra- and intergenerational redistribution will be heavily affected by increased international labor mobility, even if the phenomenon is limited to some subgroups of the population.

The second and biggest nondemographic challenge is the widespread use of a variety of early retirement programs. In fact, Belgium excels in the use of these programs, as the world-leading low average retirement age of approximately 57 for men clearly illustrates. Originally these systems were motivated by several objectives. Faced with an environment of industrial restructuring, early retirement seemed to be the royal route out of the problem for all partners involved. First, it allowed companies to lay off old workers and, if needed, hire cheaper young workers, while the government supported a large chunk of the costs. Second, older workers were also encouraged by the trade unions to leave so as to free up space for younger ones. To the present day, many older workers believe that they make a decision that is beneficial to their younger counterparts. Third, successive governments since the 1970s were also political gainers, though financial losers, in this consensus toward early retirement, because it allowed the government to show a better performance in terms of unemployment (particularly youth unemployment) and guaranteed a social peace. Lately, however, these early retirement schemes have undergone some scrutiny. Not surprisingly, the beneficial labor market effects have been rather modest if not completely absent. Recent discussions and decisions at the government level clearly move toward the direction of lifting the effective early retirement age, and hence also the sector-specific mandatory retirement ages. Financial costs of early retirement programs to the federal government have been huge, both on the income (contributions, taxes) and on the expenditure side (early retirement benefits).

The goal of this chapter is to simulate the impact of reforms of retirement income systems. The impact we are interested in resides on two levels. First, we consider the financial and behavioral impact on individuals and families. Second, we consider the financial impact on the federal government budget. We do not restrict our attention to the budgetary impact on the social security systems, but rather on all of the federal government's finances. Such reforms will have both an automatic effect on fiscal contributions, by changing contributions and benefits for a given work history (the mechanical effect), and an additional effect through labor supply responses to the reform (the behavioral effect). We will estimate the fiscal implications of both the mechanical and the behavioral effect, using our retirement probit models derived in Dellis et al. (2004) to predict labor supply responses. The result will be an estimate of the steady-state impact of the reforms on the financial balance sheet of retirement income systems.

The structure of the chapter is as follows. Section 1.2 describes the essential features of the various public retirement and early retirement systems in Belgium. In section 1.3 we explain the different components of our administrative dataset, as well as the key results of Dellis et al. (2004), which we heavily rely upon. The following section (1.4) describes the simulation methodology used. The approach can be qualified as being of a steady-state type. Our methodology implicitly assumes that there is a time-invariant social security program and time-invariant behavior, though this has obviously not been the case for the systems and the people analyzed in our sample, where both behaviors and system characteristics have evolved over time. Section 1.5 describes the simulation results obtained. Again, it is important to stress that these results have to be interpreted with due diligence because of the limitations inherent in our simulation approach. Though the results might be rather accurate for the cohort of 50-year-old workers, this might not be the case for the more general population at other ages or for other cohorts. Section 1.6 is devoted to the conclusions.

1.2 Social Security Schemes

The Belgian retirement income system relies on three very unequal pillars. First, there are the dominant public social security programs, which represent the largest part of pension income for a wide majority in the population. A second pillar consists of company pension schemes, which play only a minor role as a source of income for the average Belgian worker. Essentially, they are currently confined to the higher-income individuals in the private sector and to the self-employed, a finding that is at least in part due to their tax treatment. A third type of retirement income comes from individual retirement savings. These take multiple forms: there are tax-favored individual pension savings accounts with a maximum annual contribution of €580 per person, or under the form of more traditional savings vehicles, such as the tax-favored savings accounts, investments in trust funds, life insurance, and so on.

The first pillar, public retirement programs, essentially consists of four components. There are three large sectoral social security programs, one for the public sector, one for the private sector wage earners, and one for the self-employed. Some special categories of workers, such as coal mine workers and military personnel, have special retirement systems that we will not explicitly model in the present chapter. A fourth large category of public retirement income consists of the guaranteed minimum pension system, which operates on a means-tested basis.

1.2.1 Wage Earner's Scheme

The wage earner's scheme is by far the largest one, based on the number of people affiliated with the program. The program allows for retirement starting at age 60, with a normal retirement age (NRA) fixed at 65. The choice of retirement age does not induce any actuarial adjustment under current rules.

However, in the case of most workers, the choice of retirement age is not completely neutral with respect to the benefit amount, because a full earnings history consists of forty-five years of work for men, a condition that many people do not satisfy at the age of 60. For those having more than forty-five working years, a dropout-year provision operates, replacing low-income years by higher ones. The situation has so far been slightly different for women, who only needed forty years to complete a career. A transition (between 1997 and 2009) is under way to progressively increase the complete career requirement to forty-five years of work. Hence, for most women included in our dataset, a full career still consists of forty years of work.

Benefits are computed based on earnings during periods of affiliation. The benefit formula, which is subject to floors and ceilings, can be represented as follows:

Benefits = n/N x average wage x k,

where n represents the number of years of affiliation with the wage earner's scheme, N the number of years required for a full career (in our case either forty or forty-five) and k is a replacement rate, which takes on the value of 0.6 or 0.75, depending on whether the social security recipient claims benefits as a single person or as a household. The variable average wage corresponds to indexed average wages over the period of affiliation, with indexation on the price index combined with additional discretionary adjustments for the evolution of growth. A peculiar feature of the Belgian wage earners' scheme is that periods of one's life spent on replacement income (unemployment benefits, disability benefits, workers compensation) fully count as years worked in the computation of the average wage, and hence of the social security benefit. For any such periods, fictive wages are inserted into the average wage computation. In line with the general philosophy of the Belgian social insurance system-that any such spell on a replacement income system is purely involuntary-imputed wages are set equal in real terms to those that the workers earned before entering these replacement income programs.

Wage earners' pensions are shielded against inflation through an automatic consumer price index (CPI) adjustment and are subject to an earnings test. Currently, the earnings limit is approximately €7,450 per year. For earnings above this limit, pension entitlement is suspended. Benefits are also paid to surviving spouses, or more generally, surviving dependents of deceased wage earners.

The wage earner system is essentially based on the PAYG principle, and financed through payroll taxes that are levied both on the employers and the employees, with a combined tax rate of 16.36 percent (no earnings limit). The system also receives annual subsidies and transfers from the Belgian federal budget that amount to approximately 10 percent of overall benefits for the period considered.

Next to the official wage earner scheme, several forms of early retirement programs have been developed: mandatory collective early retirement and individual early retirement. During the 1980s and the 1990s, an arsenal of mandatory early retirement schemes was put in place. All of these arrangements were and are based on collective agreements, which are negotiated with the active involvement of employees and employers, sometimes at the sector level, sometimes at the level of an individual company or production site. For some companies in a difficult economic position, mandatory retirement ages as low as 50 were introduced. Individual early retirement differentiates itself from its collective counterpart by the fact that it is based on an individual's decision to retire from work. During the years analyzed in our sample, the most prevalent way to do this is to pass through the unemployment system, in which the unemployed aged 50 or more are considered "aged unemployed" and are no longer subject to show up at the unemployment office on a regular basis. Further, there is no control on availability to work, nor are there benefit cuts due to long-term unemployment. 8 Therefore, people unwilling to continue to work can ask their employer to lay them off. Similarly, employers can use the system to shed older, more expensive workers. The latter are often willing to do so because of a lack of experience rating in the unemployment insurance system. In the early years of the new millennium, a new technique has even reinforced the use of the unemployment insurance system as a retirement route. The technique, called canadry dry pensions, consists in a lump-sum transfer from the employer at the time the company lays off its worker. This lump sum is not formally a retirement pension, but clearly looks like one.

1.2.2 Public Sector Employees

Public sector pensions are paid out of the general federal budget and are officially considered as deferred income rather than old-age insurance. The only official insurance element is a coverage for survivor benefits, which is financed through a 7.5 percent payroll tax. No spousal benefits are available. Civil servants face compulsory retirement at the latest at age 65, for both men and women. However, for the private sector, there is a multitude of ways of retiring earlier than this normal age of 65. There is disability protection, which is a much more plausible route to retirement than in the private-sector system, as the screening is considered to be much less severe. Most importantly however, it is possible to opt for an incomplete career and retire at 60. For some particular categories of workers, the normal retirement age is lower than 65, and early retirement provisions are sometimes extremely generous (military servicemen, teachers). Public sector pensions are based on the income earned by an individual during the last five years before retirement. Benefits are computed according to a rather complicated formula but can never exceed 75 percent of the average wages over the last five years. The benefit formula can be represented as follows:

benefit = average wage over last five years x min (fract; 0.75),

where fract is a fraction with a numerator consisting of the number of years the person worked in the public service, the denominator being a benefit accrual factor. This latter benefit accrual factor, also called tantième, depends on the rank the person occupies in the hierarchy. This denominator ranges from 30 to 60, taking the value of 30 for the highest-ranking civil servants (high court judges, university professors) and 60 for the lowest ranks. As in the private sector wage earners' scheme, the system is earnings tested. The system also applies floors and ceilings, which are, however, much more generous than for private sector retirement benefits. Most notably, higher-income individuals get a much better deal in the public sector than in the private sector. This finding is reinforced once we consider indexation rules, as public sector pensions are indexed on average wages (péréquation). Public servants therefore enjoy the benefits of productivity increases in the economy even beyond the moment when they actively contribute to them as workers.

1.2.3 Self-Employed

The self-employed retirement scheme is the latest one to have been introduced, as it has only existed since 1956. It is also the least generous of the three big social security systems, with retirement benefits close to the level of the guaranteed minimum income (see the following). The self-employed are not entitled to unemployment benefits, nor to early retirement benefits. Disability benefits exist, but both qualifying conditions and financial characteristics of the system make it a most unlikely exit route to retirement. For a very long time, old-age pensions have been independent of earnings levels. However, since 1984, the system is progressively being transformed to allow for a stronger link between contributions and benefits. Additional earnings past 1984 enter the pension computation formula at their correct value, instead of some fictive amount. Full benefits are available at age 65 for men with a complete earnings history of forty-five years. However, anticipated retirement is possible as early as age 60, with an actuarial reduction of 5 percent per year of anticipation. As for the wage earners' scheme, women are in a transitory phase, with the complete career requirement shifting from forty years of work to forty-five, and normal retirement age from 60 to 65.

(Continues...)



Excerpted from Social Security Programs and Retirement around the World Copyright © 2007 by National Bureau of Economic Research. Excerpted by permission.
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Meet the Author

Jonathan Gruber is professor of economics at MIT and director of the Program on Children at the NBER, where he is a research associate. He is coeditor of the Journal of Public Economics, and associate editor of the Journal of Health Economics. David A. Wise is the John F. Stambaugh Professor of Political Economy at the John F. Kennedy School of Government, Harvard University, and director of the Programs on Aging and Health Care at the NBER.

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