“Of what avail are any laws, where money rules
alone,
Where Poverty can never win its cases?
Detractors of the times, who bear the Cynic’s scrip,
are known
To often sell the truth, and keep their faces!”–Ascyltus, from Petronius’ “The Satyricon“
In 1981, Chile adopted a privatized Social Security-like (pension) program that requires most workers to contribute 10% of their income to a private investment account. They may contribute up to 20%. These accounts are maintained by a number of private companies (known as Administradoras de Fondos de Pensiones, or AFPs) that compete for the business by advertising directly to the investing public.
These providers charge commissions and fees for certain services which are paid on top of the contributions.
An additional 3% is collected from most workers for Disability Insurance; 7% more is deducted from wages for health care.
At retirement, the money is either used to purchase an annuity from a private provider to provide a steady source of income or it’s withdrawn at a set rate over time directly from the account.
Those who are self-employed do not have to pay into the system, but they have the option to do so if they’re so inclined.
If you don’t have enough in your private account to purchase an annuity or to withdraw steady amounts over time, but you’ve been contributing for more than 20 years, you will receive a minimum pension from the Chilean Government…but you will also lose any contributions you made to your private account.
AFPs are regulated as to how they may invest; if, through investment losses, they do not have enough money to capitalize the accounts they carry they must provide the money out of their own cash reserves. If they follow the rules, and still lose so many assets they can’t continue to operate, a government bailout is in order.
At the same time, a second “welfare” program (PASIS) was established to create a “safety net” that would provide a benefit of 75% of the poverty level or 25% of your last 10 years’ earnings, whichever is higher.
You can’t collect from both programs, but it is possible to collect from neither. More about that later.
Employers do not contribute to funding the system, however, all employers were forced to give 17% pay raises to their workers to come up with the money for the workers to make their contributions. (Chile was a military dictatorship at the time, making the “forcing” process much easier than it would be in the US today.)
The system is just turning 30 years old, and we’re now seeing the first big wave of workers who are eligible to retire.
So how has all this been working out for Chileans?
The first thing we learn is that the poorest workers probably won’t do well enough to qualify for “top tier” pensions, even though it’s projected that they’ll tend to pay for the benefit over their working lives…which will reduce their income over their working lives. (It’s also projected that workers with higher incomes should do reasonably well.)
Since most workers are poor (Chile has some of the most unequal income distribution on Earth), in the end it’s starting to look like the problems of finding enough money to support the social safety net are actually getting worse, and not better.
Additionally, other problems have come to light:
–You have to find money to “transition” from one system to another, and transition costs have been quite expensive indeed: 6.1% of Gross Domestic Product (GDP; that’s a measure of the total output of an economy) in the 1980s, 4.8% in the 1990s, and 4.3% until 2037. If we were to duplicate the Chilean experience in the US economy, 6% of the 2008 GDP (about $15 trillion) means about $900 billion annually in transition costs for the first ten years, and something north of $600 billion annually for the last 37 years of the exercise.
(Keep in mind that Chile only provides 2/3 of their population with either PASIC or a pension; since we cover a higher number than that in the US, expect those numbers to come in higher than we’re guessing here.)
Why are so many not covered? Lots of workers are working outside the “official” economy to avoid making contributions that they won’t get back later (in 1994, it was estimated that only 52% of workers regularly contribute to their accounts); additionally, many women have never participated in the labor force.
–Because the service providers are competing for the business, administrative costs (read: advertising and sales commissions) have been far higher than in the US Social Security system, where administrative costs have been at .07% of distributions, or lower, since 1990. To put this another way, during the 1990s the US Social Security Administration was paying $18.70 per year to administer a claim; at the same time Chile’s various providers were paying an average of $89.10 to do the same thing.
–All that competition, some say, has lead to lots of changing of providers, which tends to make any investment program less efficient over time. (In 1996, half of Chilean workers switched providers; it’s estimated that reduced pension accumulations across the entire system by about 20%.) The Chilean Government made changes in 1997 to try to work through this problem, and they seem to have had some considerable effect.
Evidence suggests most of the switching not related to consolidation in the AFP business is being done by a small percentage of account holders, with some switching as much as eight times in a year; today the average Chilean seems to change AFPs about once every five years. Unemployment also seems to be related to switching; this because the unemployed can establish a new account with a lower set of fees if they move to a new provider.
–Many Chileans, despite living in a system that has, for almost 30 years, required them to manage their own money, actually know very little about that money.
Less than half know that the contribution rate is 10%, only 1/3 know how much (within 20%) is in their accounts, and, according to work done at the University of Chile, “few” actually know what they pay in fees and commissions.
–Those who end up in the welfare program are guaranteed 75% of the poverty level; that suggests that if you’re elderly and on welfare, you’re living in poverty. Because of limited funding, there are qualified elderly poor in Chile who do not receive any benefit.
Today, in the US, about 12% of the elderly live in poverty. Without
the current Social Security system in place, it’s estimated that 49.9% of the elderly would have been living in poverty in 2002.
–In Chile, taxes to cover the transition costs tend to rise faster than the “assets under management” for most workers, leaving them less well-off than before-an effect that is most common among the “financially illiterate”…meaning, of course, most Americans. In other words, reform, in Chile, tends to help the wealthiest and best educated at the expense of those who are less of either.
That’s a whole lot of detail, so let’s pull pack and look at the “macro” picture:
Chile has operated a version of a privatized system since 1981, and for the most part the working poor will never see any benefit from the transition. Since Chile doesn’t have much of a middle class, it’s hard to see how the Chilean experience would affect our middle class.
The US Social Security system has reduced the estimated rate of elderly poverty from nearly 50% to roughly 10%; such a reduction in poverty did not occur in Chile with their privatization.
The costs of moving to the same system here, if our experience were the same as Chile’s, would run anywhere from $600-900 billion annually for at least 50 years. Of course, since we provide a Social Security safety net to almost all of our citizens, as opposed to 2/3 of the population, as Chile does, it’s reasonable to assume our costs would be more or less 1/3 higher.
Chile forced its private-sector employers to raise wages to cover the workers’ costs of transition; I’m aware of no proposals that would, or could, impose such a cost on employers in the US.
It appears that Chilean-style privatization encouraged about half the population to engage in “under the table” work, making the funding problem for the system even worse that it would be otherwise.
Frequent switching of account providers is great for the providers, as it creates lots of chances to collect fees for opening and closing accounts and the like-but it’s not so great for the account holders, who are losing up to 20% of their potential earnings more or less because maintaining a sales force and running lots of ads are effective business practices.
It is unknown what happens when a shock like the recent recession hits the system, and we are awaiting research that will help us understand what happens when and if the State is required to refund losses incurred by the AFP if they “follow the rules” but still lose so much money that they lack sufficient capital to operate.
The costs of operating the PASIS program go up even as the cost of operating the retirement accounts are also still high, and the question of whether Chile can continue to expend “safety net” coverage to the 30% of the elderly poor who are not covered remains unknown.
So there you go: there are going to be lots of proposals to privatize Social Security this year, “getting a Chilean” may well be one of the options you hear Conservatives promote-and hopefully by now you have some idea why this doesn’t look like nearly as good an idea as some folks would tell you it is.
Next time, we’ll talk about proposals to invest Social Security money in Treasury debt, and whether such an effort is actually an investment at all.
It’ll be at least medium geeky…and hey, who doesn’t love that?
…so hey, with that out of the way, let’s get back to work.
Reminds me of an old joke.
<
p>Seriously – to end all this noise about SS, remove the income cap on contributions.
…one step further: if a person makes $2,000,000 in “wage” income, and manages to book an $18,000,000 gain on stock option compensation the same year, only 10% would be taxable for social security and medicare purposes (remember, medicare is the big economic problem) under any “remove the cap” proposal floating around today; we might need to consider how to capture some portion of that 90% as well.
…fantastic joke.
You can’t just remove the cap on contributions without increasing the benefits paid out to those who make all these new contributions. Otherwise, the entire program becomes a politically unsustainable welfare system.
<
p>If (I wish) impose the SS withholding on my full $2,000,000 salary, and then have to pay me 10x the benefits upon retirement, does that help the broad picture, does it wash, or does it lose?
Do those paying higher income taxes get to drive on better roads? Do people who pay more property taxes get better library services, or quicker firefighter and police response?
<
p>The income cap makes the SS tax regressive. Get rid of it.
They are not taxes. It is a pension system. Social Security doesn’t pay for roads. Social Security pays for Social Security.
<
p>You want to convert it from a pension system to a “general revenue” welfare system. I think that this would amount to an abolition of the system. Even if you succeed in replacing it with a welfare system, it will only be a matter of time before that welfare system gets the AFDC treatment.
Social Security and Medicare taxes.
<
p>Just because you want to call them something else doesn’t make it so.
…but on the other side is the fact that the oasi and di trust funds are running on general revenue already, to the extent we’re borrowing–and eventually repaying–money from the oasi and di trust funds to fund general budget operations.
<
p>so the question may actually be one of political sustainability…and to that: how politically sustainable is it going to be to tell grandma to starve?
<
p>that won’t be a tough sell, and a candidate who gets how the youtube works will be able to campaign well on the concept that we should provide things like heath care and..well, you know, food and shelter…to people that are starving.
<
p>you might even go out and give a speech like this:
<
p>
<
p>i’m told such a speech can be pretty effective, politically, and i think i’d rather be on that side of the argument than the other.
meant to say “that will be a tough sell…”
…without having read this one first…but obviously, i couldn’t agree more.
There are about 14 million people in the US who make over $100K and about 146 million registered voters. That’s 9% of the voting base – if we kept the increase to just the 4 million or so who make over $200K, that’s only 3% of the electorate.
<
p>You’re saying it’s not politically sustainable to ask the richest 3% to pony up some cash to make sure our grandparents don’t have to eat cat food to survive? It’s time we started celebrating social security as a welfare system – because it’s ridiculous in the richest country in the history of the world that we discuss the prospect of forcing people to work till 70 because a bunch of capitalist have to admit that their perfect market doesn’t ensure prosperity for all.
You are trying to make the system into something that it was not designed to do. It was not designed to fund decades of income to retirees, and was certainly not designed to operate as a “progressive” tax.
<
p>It was specifically designed NOT to be a welfare system, because to make it a welfare system would render it politically vulnerable. I don’t think that anything has changed to change the wisdom of that decision. Why should taxpayers fund someone’s lifestyle decisions?
Social Security is “based” on what you pay in, but that’s not the only factor – many get far more in benefits than they ever paid in. That’s the system we have right now and that’s the system that people support.
<
p>Eliminating the cap would only be explicitly tweaking the formula for the existing system – which is a welfare system – it may have been expedient to say it’s not, but when some people are paid 10, 20, even 100 times what they contributed, that’s a welfare system.
<
p>I also take issue with this notion that “converting” social security to a welfare system makes it politically vulnerable – it’s currently politically vulnerable. Bush tried to privatize it, the current Republicans and conservative democrats want to raise the age of retirement or cut benefits – others want to establish a means test. These are all major changes – as significant as forcing a few million millionaires to pony up more cash to stabilize the fund. The difference is the millionaires can afford it.
<
p>And I assume by “lifestyle decision” you mean the failure of our capitalist system to equally distribute opportunity, access, and shared resources?
And many get far less. If say, they get run over by a truck on their 62nd birthday. When they established the system, the age when one could receive benefits wasn’t all that long before they were expected to pass away, and so the ones collecting for longer would and the ones who died younger would wash. Hence “insurance.”
<
p>Nevertheless, If I earn at or near the cap for many years, my monthly payment will be significantly greater than the benefit payment of a person who worked for fewer years, at lower pay. If you alter that to make my payment the same as someone who didn’t contribute as much, for as long, then it becomes something else: not insurance against poverty in old age, but a remedy for poverty in old age.
<
p>As soon as that is the case, then people will find a way to game the system to maximize their benefit– just as is presently done with Medicaid. These people might be rare, but they will be intensively irritating, and the system will go from being the third rail of American politics to a useful wedge issue.
<
p>I dispute your notion that the system is presently politically vulnerable because someone proposed to privatize it. They don’t call it the third rail of American politics for nothing, and when Bush touched the rail, he got zapped. Oh, and by the way, please note how the proposal went over like a loud fart in church. His Republican Congress, which theretofore took orders from the White House, simply ignored the president’s agenda in 2005. That was the end of the powerful phase of his presidency, and after that he spent the rest of his time counting down to Jan 2009.
<
p>The system is presently financially vulnerable, because it relies so heavily on government debt. No doubt Bush, in selling his own DOA proposal, vastly overstated the severity of the crisis; the system is not, and will not soon be “near bankruptcy.”
<
p>But that does not mean that there is not a problem, because it cannot pay-as-you go, and therefore must rely too heavily on ever-expanding federal debt. This could best be remedied by a combination of (i) increasing the retirement age; (ii) increasing the payroll tax; and (ii) increasing the cap on the payroll tax. In my view, this last requires an increase in the top benefit base as well in order to preserve the nature of the system, and therefore may not be an effective fix.
<
p>Do I expect that this will happen? No. I expect that Republicans will contend- if they contend anything- that the system is bankrupt (more likely, they will STFU about social security, except in the occasional paper from the Club for Growth), and Democrats will contend that there is absolutely nothing wrong, and therefore nothing will change at all. Then, when the debt problem becomes a big problem, the necessary fix will be something that something neither liberals nor moderates like.
…and i have a feeling that you have to consider something like that to make the math work.
<
p>and i don’t see that as a big political or “fairness” problem either: if you retired and making $250,000 a year…is it really gonna be that tough to get by without that extra social security money?
<
p>i’ve also heard that raising the ssa/medicare tax to 14.5% for all workers will accomplish much the same thing.
<
p>that said, i’m not aware of math that works if you just raise the income cap on ssa/medicare taxes, and i’m not sure a proposal that would raise the tax only on the most wealthy would gain as much political support as raising the tax cap would.
How do you means test? Last few years of income? So, I quit my job for several years before SS age. I can afford some low-income years; I’ve been making $250K a year.
<
p>A longer look back? Well, I had that one fantastic year working for kozmo.com, but when they went bust it was back to normal income for me. Do I get stiffed out of Social Security now?
<
p>Average income over working life? What about the guy that actually did invest his life savings in Florida swampland. The very thing that makes us all dislike the Bush privatization proposal. Do you lose your protection from poor investment decisions if you make poor investment decisions?
<
p>Assets? I don’t have any, everything belongs to my kids. I already qualify for Medicaid, in case I have to go to a nursing home. If I qualify for Medicaid, how do I not qualify for means-tested Social Security?
that having been stolen from how they do it in chile.
<
p>if masses of americans with high incomes decide to go into early retirement, it may not necessarily be such a horrible thing–and to the extent this could create “new blood at the top” in potentially ossified family businesses or allow employers to lower the cost basis for certain top-level jobs, it may actually prove to be a benefit.
<
p>but there’s a bigger question that must be addressed in this form of game theory: opportunity cost.
<
p>if i have the potential to make $7.5 million in my last ten working years, is it worth giving that up–and dipping into my current retirement savings for an extra decade–to collect some amount that will grow into the hundreds of thousands of dollars over the following two or three decades…assuming i live that long?
<
p>for a lot of the folks facing that choice, quitting early’s going to look like a bad business proposition, and i suspect most of them are financially sophisticated enough to figure that out, or they have advisors who will figure it out for them.
…just as you don’t get 10x the highway when you drive a truck and pay road taxes or get 10x the army when you pay lots of income taxes.
<
p>and it doesn’t seem any more odd to me to tax income for social security/medicare purposes than it does to tax that same income for capital gains or ordinary income purposes.
I regard that advocacy of repeal, and adoption of a new, different system.
<
p>Here’s the new system: No separate payroll tax, no portion of the payroll tax paid by employers, because the system is no longer a function of one’s employment, income, or contributions.
<
p>Raise the income tax, by an enormous amount, to pay for a new system that is strictly a welfare pension system, that pays, say $3,000/month per retiree, but sunsets out so that “rich” retirees don’t get any. (This will be super-easy to administer, and won’t ever be abused, just like Medicaid). You can call it Aid to Families With Dependent Seniors.
<
p>You might even get it to pass, as the Me Generation that is so fond of discovering its “rights” to free stuff– and which voted itself decades of tax cuts– would get a pretty sweet deal.