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Lessons From Around The World
International pension programs offer valuable lessons for Social Security reform proposals
By GEORGIANNE OCASIO TEISSONNIERE
February 24, 2005
The need for Social Security reform seems to have the entire nation on edge. President Bush and the Republican Party for the most part, have informally proposed the creation of personal accounts that would allow workers to privately invest up to four percentage points of the 12.4% of the yearly payroll taxes they would traditionally give to the fund. Investment options would be limited, but under the control of the participant. In exchange, the government would eventually reduce benefits for those workers who hypothetically will be receiving enough money for retirement from the investments of their private accounts.
Although the plan would be strictly voluntary, Democrats and the American Association of Retired Persons (AARP) have fervently joined in opposition to the proposal, instead promoting other less drastic reforms for the program. Meanwhile Wall Street, which according to many experts could earn a lot of money from managing all the new private accounts, has publicly stayed on the sidelines, although in private they are said to be lobbying for the presidents proposal. While all this internal debate continues raging across the nation, few seem aware that personal pension accounts are nothing new. Similar reforms have been implemented all over the world, some successful, others not. Whatever the case, the international results of these reforms serve as valuable lessons for those on both side of the debate.
In Britain, all retirees get payouts from a basic state pension in addition to supplementary state plan benefits. In 1988, concerns over the baby-boomers upcoming retirement led the British government to allow consumers to opt out of the supplementary state pension plan and set up private accounts. It also let employees get out of company pensions and use part of their payroll taxes to fund their personal accounts. With the stock market booming, the plan seemed logical. Insurance company salespeople persuaded many people to switch to private accounts. However, for the most part the returns on the private plans didnt meet expectations. Regulators forced insurers to compensate customers whod done worse by switching to the private accounts. Up to the moment, payments have totaled about $24 billion. Needless to say, this scandal prompted many to opt out of the system. Last year 200,000 people canceled their private accounts, and the same number is expected to follow suit this year.
Singapores system is called the Central Provident Fund, and imposes a 20% payroll tax on employees and 13% on employers in order to fund three private accounts, one for healthcare, one for housing, education, and other approved investments, and another one for retirement. Workers can access the accounts before retirement; in some cases, they can even borrow from future payments. The problem is that a lot of Singaporeans dont have enough money at the time of retirement because of the early access to the funds.
In Argentina, private pension accounts were set up a decade ago. Workers were allowed to stay in the current system or set up the personal accounts; most chose the latter, leaving the government with considerably reduced funds to pay out the existing retirees. The transition was planned to cost less than 1% of GDP annually, the equivalent of $2.5 billion. However when economic crisis hit in 2001, budget deficits grew exponentially, and the government was forced to borrow billions more than they had projected. The same problem affected Bolivia, where the budget deficit more than doubled because of higher than expected transition costs. The government has not been able to pay many retirees their promised benefits. On the U.S. mainland, the cost of the transition is estimated to be between $1 trillion and $2 trillion for the first 10 years, which would be added to the present deficit that is projected to amount to approximately 3.5% of GDP in each year over the next decade, according to economists at the Brookings Institute.
But the news from abroad is not all grim. Chiles model of pension reform stands as a success story among the rest. Assets in the private accounts amount to $54 billion, close to two-thirds of national output. The way the system functions is that workers deposit their full contribution, 10% of pretax wages, into individual accounts. In addition, about 2.3% is deducted from wages for administrative fees and insurance. Employers dont match contributions. From 1981 to 1995, returns on stocks were 12.7% a year because of favorable local market conditions. From 1996-2004, average returns were a still healthy 6.5%. Administration costs, which amount to 20% of the total deposited, have clouded the prospects for the plan a bit, although it does remain strong and is lauded internationally by many. However, it is important to point out that in Chile, participation in the personal account system is mandatory, which helped the government implement the plan in a more uniform manner than would happen in the U.S.
Yet, proponents of the private account system insist that the voluntary aspect of the proposal is vital to win public support in the U.S. They also insist it isnt necessary to look abroad for reform lessons, for there is a historical system already in place at home that serves as a perfect model. The Thrift Savings Plan (TSP) is the government pension plan for federal employees, and it works in much the same way that the private account proposal would function. Congress established the TSP in the Federal Employees Retirement System Act of 1986, offering employees many of the benefits of traditional 401K retirement plans. Federal employees are allowed to choose from five investment options, as would participants of the private account proposal for Social Security. In the past 10 years, the TPS has posted returns of 11% in its large-capitalization stock fund, 9.7% for small-cap stock fund, and 6% for the short-term bond fund; 2.4% must be subtracted from those returns on account of inflation adjustments. However, these returns reflect double-digit percentage gains in the stock market during the late 1990s, conditions that are unlikely to repeat themselves in the foreseeable future according to many analysts. The White House estimates private accounts could earn a 4.6% rate of return after the cost of administration is subtracted, unless participants were to invest solely in Treasury bonds, which would return 3%, the same return as the traditional system.
So, the international and local lessons seem clear. From Britain, the lesson is that any reform should protect the system from being exploited. The Singapore moral is that early access to retirement funds could defy the purpose of the system. Argentina and Bolivia offer warnings of the effects of excessive transition costs and growing budget deficits. On the other hand, Chile and the federal TPS plan show the potential benefits of the private account proposal, as long as the market is in the mood to cooperate.
This Caribbean Business article appears courtesy of Casiano Communications.