Report No. 19641-BR Brazil Critical Issues in Social Security (In Two Volumes) Volume I: Summary Report June 19, 2000 Brazil Country Management Unit Latin America and the Caribbean Region Document of the World Bank CURRENCY AND EXCHANGE RATES (R$IUS$) Currency Unit - Real (R$) December 1995: R$0.97 December 1996: R$1.04 December 1997: R$1.12 December 1998: R$1.21 December 1999: R$1.84 April 2000: R$1.76 WEIGHTS AND MEASURES The Metric System is used throughout the report. FISCAL YEAR January 1 to December 31 Vice President LCR: David de Ferranti Director LCC5C: Gobind T. Nankani Lead Economist: Suman K. Bery Task Manager: Indermit S. Gill ABBREVIATIONS AND ACRONYMS BNDES National Development Bank (Banco Nacional de Desenvolvimento Econ6mico e Social) CLT Consolidated Labor Code (Consolidag5o de Lei do Trabalho) DATAPREV Parastatal agency providing data support to the Ministry of Social Security (Empresa de Processamento de Dados da Previd6ncia Social) DB Defined Benefit Pension Plan, where pensions are based on a formula based on years of service and earnings DC Defined Contribution Pension Plan, where pensions depend on contributions and investment earnings DEPEM Department for Pension Regimes of States and Municipalities in the Federal Ministry of Social Security (Departamento do Regimes de Previd6ncia dos Estados e Municipios) EET Regime that Exempts pension contributions from taxation and Exempts investment income, but Taxes pension benefits. FAPI Long-term Investment Plan administered by Mutual Fund Companies (Fundo de Aposentadoria Programada Individual)l FGTS Severance Fund (Fundo de Garantia por Tempo de Servigo) FGV Getulio Vargas Foundation (Fundag5o Getulio Vargas) GDP Gross Domestic Product (Produto Bruto Intemo) IBGE Brazilian Institute of Geography and Statistics (Fundagao Instituto Brasileiro de Geografia e Estatistica) IMF International Monetary Fund (Fundo Monetario Internacional) INSS National Social Security Agency (Instituto Nacional de Seguridade Social) IPD Implicit Pension Debt IPEA Institute of Applied Economic Research (Instituto de Pesquisa Econ6mica Aplicada) MPAS Ministry of Social Security and Social Assistance (Ministerio da Previd6ncia Social e Assistencia Social NDC Notional Defined Contribution Pensions (Contas Escritura! OECD Organization for Economic Cooperation and Development PAYG Pay-As-You-Go PGBL Pension Plan administered by Open Pension Funds and assets managed by Mutual Funds (Piano Gerador de Beneficio Livre) PME Monthly Employment Survey (Pesquisa Mensal de Emprego) PNAD National Household Survey (Pesquisa Nacional por Amostra dos Domicilios) PPV/LSMS Living Standards Measurement Study (Pesquisa das Padroes da Vida) PROST Pension Reform Options Simulation Toolkit 3 RGPS General Regime for Social Security (Regime Geral da Previd6ncia Social) RJU Pension Regime for Government Workers (Regime Juridico Onico) RPC Regime for Complementary Pensions (Regime de Previd6ncia Complementar) SEAP Secretariat for State Administration, Federal Govemment of Brazil (Secretariat de Estado da Administracao e do Patrim6nio) SEAP-P Secretariat for Social Security - Government of the State of Parana (Secretaria Especial para Assuntos de Previdencia). SPC Secretariat for Complementary Pensions (Secretaria de Previd6ncia Complementar) SUSEP Regulatory Agency for Open Funds (Superintendencia de Seguros Privada) 4 ACKNOWLEDGMENTS This report consists of two volumes. Volume I contains a detailed summary of the report's findings and their policy implications, written for a general audience interested in the main messages of the report. Volume 11 is the Policy Report which is directed at policy makers and specialists, and contains discussions of the most important policy recommendations for each of the components of the Brazilian social security system. The report was prepared by a World Bank team consisting of Indermit S. Gill (Task Manager, LCSHD), Truman G. Packard (Social Protection Specialist, LCSHD), Juan Yermo (Consultant, LCSFP, now with the OECD), Anita M. Schwarz (Senior Human Resources Economist, HDNSP) and Dimitri Vittas (Lead Economist, DECRG). The report was produced under the supervision of Gobind T. Nankani (Director, Brazil Country Management Unit - LCC5C), Suman Bery (Lead Economist, LCC5C), and Eliana Cardoso (Lead Specialist - Economic Policy, LCSPR). Robert Holzmann (Director, Social Protection, HDNSP) provided guidance and advice to the team throughout the process. The peer reviewers were Louise Fox (Lead Specialist - Pensions, HDNSP), P.S. Srinivas (Financial Economist, LCSFP), and Mariluz Cortes (Principal Operations Officer, LCSFP), and the outside reviewers were Olivia S. Mitchell (Professor, Wharton School - University of Pennsylvania) and Francisco E. B. Oliveira (IPEA - Rio de Janeiro). This task was carried out in close collaboration with the Federal Government of Brazil, especially with officials of the Ministry of Social Security (MPAS) under the leadership of Minister Waldeck Ornelas. The report team is thankful to many persons in MPAS who patiently provided guidance and encouragement, especially Vinicius C. Pinheiro (Secretary of Social Security), Marcelo Viana Estevao (former Secretary for Social Security), Paulo Kilass (Secretary for Complementary Social Security), and Marcelo Caetano. The report team is also grateful to officials of the Govemment of the State of Parana for their help in understanding the complexities of state pension systems. We would especially like to thank Governor Jaime Lerner, Renato Follador Junior (Special Secretary for State Pensions), Miguel Salomao (Secretary for Planning), Alcyone Saliba (Secretary of Education), and Claudia Busnardo. Others who cheerfully provided help whenever asked are Kaiz6 Beltrao (IBGE - Rio de Janeiro), Bruno Konder, and Rigan A. Gonzalez (DATAPREV - Rio de Janeiro). George Kopits, Sandy MacKenzie, Robert Gillingham, and Alberto Ramos of the International Monetary Fund provided useful analysis and comment. At the World Bank, Chris Parel (LCC5C), Aniruddha Bonnerjee, David Lindeman, Robert Palacios, and Asta Zviniene (HDNSP) provided valuable insights and support. The collaboration of many other Government officials, other individuals and institutions is gratefully acknowledged. Nevertheless, the opinions presented here are those of the World Bank and should not be attributed to any of the individuals or institutions acknowledged above. 5 TABLE OF CONTENTS VOLUME 1: SUMMARY REPORT ABBREVIATIONS AND ACRONYMS ......................................................3 ACKNOWLEDGMENTS .......................................................5 CONTENTS OF VOLUME II ......................................................5 I. DIMENSIONS OF THE SOCIAL SECURITY CHALLENGE .......................................................8 System components and main problems ......................................................8 Unsustainable fiscal imbalances ......................................................9 Gaping inequities and actuarial imbalances ...................................................... 10 Unnecessarily high efficiency costs ...................................................... 11 Low coverage of funded schemes ...................................................... 12 II. THE GOALS OF REFORM ...................................................... 13 Reducing fiscal imbalances ...................................................... 13 Lowering actuarial imbalances ...................................................... 15 Increasing equity and redistribution ...................................................... 17 Reducing collateral inefficiency ...................................................... 17 Facilitating expansion of funded schemes ...................................................... 19 Ill. THE POLICY INEVITABILITIES ................0........... 20 Subsidies for government pensions have to be reduced ....................................... 20 Replacement rates have to be lowered ....................................... 20 The reference period has to lengthened uniformly ....................................... 21 A minimum retirement age has to be instituted ....................................... 22 Funded pensions have to grow in importance ........................................ 22 Taxes to finance first pillar pensions have to be lowered eventually ................... ..................... 22 [V. OTHER POLICY CHOICES .......................... 23 First-pillar pensions could be kept minimal .......................... 23 RJU and RGPS can be integrated .......................... 23 Third-pillar growth may make (mandatory) second-pillar unnecessary .................................................... 24 Assistance to the elderly poor could be better targeted .................................................... 24 V. SUMMARY AND CONCLUSIONS ...................................................... 26 The criteria for evaluating reform measures ...................................................... 26 The progress made ...................................................... 26 The challenges ahead ...................................................... 27 TABLES ...................................................... 29 Table 1: Objectves of social security reform and measures consistent with these goals ................ ......... 29 Table 2: RGPS - Problems, best practce, and policy recommendations ................................................... 30 Table 3: RJU - Problems, best practice, and policy recommendations ...................................................... 31 Table 4: SCP - Problems, best practice, and policy recommendabions ...................................................... 32 Table 5: State Pension Funds - Problems, best practice, and policy recommendations ........................... 33 6 VOLUME II: POLICY REPORT ABBREVIATIONS AND ACRONYMS ........................................................ , III ACKNOWLEDGMENTS.IV 1. SOCIAL SECURITY AND PENSIONS: COMPLETED REFORMS & REMAINING AGENDA . I Background and Main Policy Questions .1 Fiscal Imbalances in the RGPS and RJU ......................................5 Inequity and Actuarial Imbalances in the RGPS and RJU .....................................,.,.,.,.,., . 11 Efficiency Costs of Brazil's First-Pillar Schemes Before Reform .................................... 14 Weaknesses in Regulation and Supervision of Pension Funds .................................... 15 The Feasibility of Pension Funds for Govemment Workers .................................. 16 A Road Map to the Report .................................. 17 References for Chapter I .19 II. THE NATIONAL SOCIAL SECURITY SYSTEM .21 Introduction .......21 The RGPS Before the 1998-99 Reform ...................... 21 Constitutional Reforms of 1998 and Their Impact ............................ 31 Towards a Strategy for Sustainable Reform .33 The Likely Impact of the New RGPS Benefit Formula .............................. 45 Social Security or Assistance for Brazil's Rural Poor .............................. 49 References for Chapter II .............. ... . . ,,,.,,.,,,,,.,,,.61 Ill. THE PENSION REGIME FOR GOVERNMENT WORKERS .63 Introduc..on.63 The Federal Regime Juridico Onico .65 The Regimes Juridico Unico at the State Level .77 A Cross-Country Comparison of Government Pensions . 90 Summary and Conclusions ................................... ,,, 95 References for Chapter Ill .99 IV. THE COMPLEMENTARY PENSION SYSTEM .10 Introduction ...................... . . . . . ... . . 101 The Complementary Pension System ................................ 103 Regulation and Supervision of Complementary Pensions ................................ 112 Long Term Savings Instruments ................. 129 Summary of Findings .,. 131 References for Chapter IV ............. 135 V. PENSION FUNDS FOR GOVERNMENT WORKERS . 138 Introduction .. . . . . . ..138 Government Pensions and the 1998 Constitutional Amendment ......................................,,.,.,.,.,.,.139 Pre-Funding RJU Pension Liabilities .140 Prospects for RJU Reserve Funds .147 Prospects for RJU Complementary Pension Funds ............................. 157 Redesigning RJU Pension Plans . 163 Summary of Findings .................... 165 References for Chapter V .168 VI. POLICY RECOMMENDATIONS .169 7 1. DIMENSIONS OF THE SOCIAL SECURITY CHALLENGE 1. Brazil's social security system faces problems of unsustainable fiscal deficits, inequities and actuarial imbalances, unnecessarily high efficiency costs, and lack of diversification due to low coverage of funded schemes. To illustrate the need for changes, this section examines the state of the system before the effect of reforms carried out during the last few years. Components and main problems 2. Brazil's social security and pensions system consists of three parts, with proposals to establish what may be regarded as a fourth: The principles of * The national social security system (RGPS), administered by the the Brazilian Federal Government's Institute for National Social Security (INSS), reform are to which about half of the labor force of 60 million contribute, and greater equity beneficiaries number 19 million. through * The pension regime for government workers (RJU), elimination of administered by the Federal Government, and all state and many abuse and municipal governments for their workers; contributors and uniform beneficiaries each number about 3 million. treatment, - Funded pension plans to supplement RGPS pensions (SCP): greater Privately managed, intended to supplement RGPS benefits; g contributors number 3 million and beneficiaries 1.5 million, but the thegh catie n industry is dominated by pension funds of public enterprises. rough cretiv o industry ~~~~~~~~~~~~~of individual - Funded plans to guarantee RJU benefits or to supplement accounts, and them are being proposed, and state govemments are especially economic stability keen on setting up these funds for their employees. Some states such as Bahia and Parana have already taken steps to do so. through fiscal This report examines the critical issues for reform in each of these four and actuarial components, examining both the inter-linkages and balance between them balance. (mainly in Volume I) as well as suggesting component-specific remedies (mainly in Volume II). - 3. In terminology popularized by the World Bank, Brazil's system of old age support has a large mandatory publicly-managed pay-as-you-go first pillar consisting of the RGPS and the RJU, and a relatively small (but growing) voluntary privately-managed funded third pillar consisting of the SCP. Brazil does not have a second pillar, viz., a mandatory funded component, which most countries in Latin America now do. Countries with a large third pillar, such as the USA, also do not have mandatory nationwide funded schemes. But after the reforms in many Latin American countries during the 1990s, Brazil is alone among its neighbors in having a large first pillar, no second pillar, and a relatively insignificant third pillar. 8 4. The reliance of the majority of Brazilians on a single source of formal old age support, viz., the federal government, leaves them vulnerable to all the dsks associated with holding an undiversified portfolio. Over-reliance on government in Brazil results in pressure to maintain public pensions at high levels, leading to spiraling public financing requirements, exacerbating labor market distortions and diverting resources from social services such as education. In 1999, for the first time, government expenditures on social security on 21 million retirees exceeded its education spending on 48 million students. In a country as youthful as Brazil-with five times as many people below 20 years of age as there are _ above 60-these changes signal a worsening misallocation of public resources. Social security has jeopardized current growth by contributing to Brazil's large In 1999, for the public debt; it now threatens prosperity for many years to come by diverting first time, resources from investments in the future. Brazil-a Unsustainable fiscal imbalances relatively youthful 5. The most obvious indicator of the affordability of the social security country-spent system are fiscal balances. By this measure, Brazil cannot afford the social security system it has. The accounting deficits (receipts minus expenditures) in more public the RGPS and Federal RJU were about R$9.5 billion and R$22 billion in 1999. resources on its Simulations conducted for this report show that without reforms, RGPS and 21 million Federal Executive Branch RJU deficits will increase to R$20 billion and R$23 retirees than the billion respectively in 2005, and to about R$40 billion each by 2010. RJU 48 million numbers need to be adjusted upwards by one-thirds to account for the relatively students generous judicial, legislative, and military pensions, for which simulations were enolled n t not carried out (see Volume II for details). Comprehensive information on fiscal enr i its imbalances in state and municipal RJUs is also not available, but Ministry of pre-schools, Social Security data suggest a similar magnitude for subnational RJUs schools, combined. Using simulations for the Federal Executive RJU and these rules colleges, and of thumb for extrapolation, the numbers clearly show that while the RGPS universities eventually would have become the larger burden, the RJU remains the more serious problem on fiscal grounds for the next 15-20 years unless deep reforms _ are carried out for the federal and subnational RJU (See Figure 1). Without Reform, Brazil's RGPS Would Have Become a Larger Fiscal Drain Than the RJU, But Only After 2015 -3 * -4 X5 .3RGPS - Federal Executive Branch RJU l -7 2000 2005 2010 2015 2020 Figure 1 9 Gaping inequities 6. In a country with high levels of income inequality, even a fiscally burdensome social security system may be worthy of subsidization if it serves the poor well, or if it is redistributive in its aggregate effect. But a large part Brazil's public pensions is currently structured to subsidize the relatively well-off more than the poor. Statistics indicate that less than 1% of social secudty spending reaches the poorest 10% of Brazilians, while _ about 50% is cornered by the wealthiest 10%. Through its generosity, the system also implicitly transfers wealth from future generations to current Without reform, workers/retirees. Figure 2 also shows that the Federal Govemment pays the gap about R$17,500 annually as a per retiree subsidy for pensions of between annual govemment workers, after imputing contribution-as-employer by the Federal government at twice the rate for employees (as in the RGPS). The annual subsidy for RJUs nationwide is about R$8,000 per beneficiary, compared government with less than R$11,000 for the RGPS. These numbers reflect differences subsidies to the in benefit levels, eligibility rules and system dependency ratios. If left typical RGPS unchecked, the gap between annual Federal government subsidies to the and RJU typical RGPS and RJU participant will grow from R$16,000 to R$80,000 participant between 2000 and 2020. Salary, pension, and job security levels in Brazil's federal government are often higher than for similar workers in the grows from private sector. While the average benefit in the RGPS is less than two R$16,000 in minimum salaries (or R$ 250 per month), the average benefit for retirees 2000 to from the federal judiciary is more than forty times the minimum salary (or R$80,000 by about R$6,500). Reduction of differences between the RJU and RGPS will 2020 be a big step towards greater equity and better redistribution in Brazil's social security. Cutting RGPS benefits (e.g., through the new benefit formula) without also reforming RJU pensions will exacerbate income inequality even if it helps to contain the overall fiscal burden. Subsidies Per Beneficiary in Brazira RGPS and RJU Grow But By 2020, The RPU- RGPS Gap Grows Five-Fold to R$80,000 Annually -20 t -60 -80 -100 -120 - 2000 2005 2010 2015 2020 Selected Yeams of Smulatlon 0 RGPS Per Capita Deficit RJU Per Capita Deficit Figure 2 10 Unnecessarily high efficiency costs 7. In the case of the RGPS, these generous benefits have had to be financed by rates of payroll taxes that-despite being among the highest in the world-have proved to be inadequate. RJU benefits have largely been financed from general tax revenues, as the regime is only now taking on the contributory features of a PAYG system. Brazil raises taxes of about 33% of its GDP, among the highest rates in the world, and still has to borrow to meet its public expenditure needs. The IMF estimates that direct expenditures for public pensions and the cost of servicing the debt incurred on its behalf are almost 10% of GDP. Along with The structure of administrative weaknesses in the social security system and flawed and enforcement of labor laws, onerous levels of taxation are believed to be a administrative principal cause of the high and growing informality of employment in Brazil. Figure 3 shows a steady decline of the share of formal weaknessesin employment in the six largest metropolitan areas in Brazil over the last two both the decades. Some observers argue that the labor-related distortions due to unreformed high INSS payroll taxes make RGPS reform more urgent than RJU RGPS and RJU reform. This report reasons that tax-related distortions arising because of imply large tax- RJU financing needs-which are currenty three times as large as those of P Y ti the RGPS-may be as or more serious. When fiscal, equity, and relateddistortions efficiency concems are all considered, reform of the RJU will remain the and labor market higher priority for some years to come. inefficiency The Fraction of VHrkers Paying Social Security Tax Has Fallen by 40 Percent in Brazil Since 1980 100 90 80 70 66.3 E 60 - 554 50U. | 48 46.8 45.7 445 4 S50 -4. 244. i40- ~30- 20- 10- 1980 1985 1990 1991 1992 1993 1994 1995 1996 1997 Figure 3 11 Low coverage of funded schemes 8. While funded company pension plans manage about R$100 billion worth of assets, coverage of funded pension plans remains low at about 5% of the workforce (see Figure 4). The low coverage of this third pillar of old age security is somewhat surprising for a country with one of the most sophisticated capital markets in the developing world. Given this institutional strength, the likely reasons for this are an unfavorable tax treatment for retirement accounts, an inadequate regulatory/supervisory structure that does not inspire investor confidence, and the generosity of Given Brazil's unfunded first pillar pensions. Almost all OECD countries have an "EET" model, where pension contributions and investment returns are exempt for robust capital taxaton, and only pension benefits are taxed. Brazil in contrast has what markets, the can be described as "eet" system, with limits on such exemptions but also likely reasons considerable uncertainty of treatment. Reducing the tax burden and for low coverage promised benefits in first pillar pension systems are the other instruments of funded for faster growth of pension funds in Brazil. In 1980, pension fund assets pension as a fraction of GDP in both Brazil and Chile were 1% of GDP; today, while this ratio is about 10% in Brazil, it is more than 40% in Chile, where schemes are wide-ranging social security reforms addressed these weaknesses. uncertain tax treatment, The Cwrge of Enper-Spoar0re (Furd4 Schdens in Brazl is a inadequate Frcdon dOECD Les supervision, and 120 the generosity of 100 the two 100- 90 go 92 - unfunded 83 schemes- the 80- Regime Geral and the Regime 46 50 n0 42nn50 Juridico Unico E O X ic C E = - X X co C. c 0 E C z c Figure 4 9. Setting up employer-sponsored pension funds for government workers will increase the coverage of funded schemes, but under current conditions these funds are not sustainable (more on this below). 12 11. THE GOALS OF REFORM 10. The Brazilian government's reform efforts aim to reduce fiscal deficits, lower actuarial imbalances, increase equity and redistribution, reduce collateral inefficiencies, and facilitate growth of funded pension schemes. Reducing fiscal imbalances 11. Fiscal balance is the main and immediate goal of the Brazilian reform. In the RGPS, this is mainly sought by ending reduced pensions - (aposentadoria proporcional and introducing a new formula for calculating pension benefits (called fator previdenciario in this report), a change finalized The goals of recently and whose effects are yet to bear fruit. Simulations of the effect of the Brazil's reform first measure-the elimination of reduced pensions-showed gains until 2010 efforts are-in over what would have occurred without this reform, as people wait longer to order of get unreduced benefits and the reference wage is lowered. But without further urgency-to reform, the changes could, under some assumptions, even have actually reduce fiscal worsened fiscal imbalances over the medium to long term, as those who deficits, lower would have retired with reduced benefits (70-99% of reference salaries) would begin to retire with unreduced (100%) benefits. The main achievement of the actuarial first round of reform was-by removing the benefit formula from the imbalances, Constituton-to make deeper reform easier. The government has used this increase equity space to introduce the new formula which can result in measurable fiscal and gains (see Figure 5). While not guaranteeing to return the RGPS to balance ditrbut (except under optimistic assumptions regarding how individuals postpone redIse bluteon, retirement in response to incentives to work longer built into the fator reducecollateral previdenciario), these measures will result in measurable short-, medium- and inefficiencies, long-term fiscal gains if implemented rigorously. But without a legal minimum and facilitate retirement age, these gains cannot be regarded as certain. growth of funded _ ~~~~~~~~~~~~~~~~~~pensions. Recent RGPS Reforms*-If Implemented Rigorously -Will Yield Significant Fiscal Savings 2 - 1 - A UW12U 1 -72- -5- -6 -7 - _ _ _ _ _ _ __ _ _ _ Base Case Amendment 20 New BenefitFormula- New Benefit Formula -No Workers Respond to Response to Incentives Incenbves Simulation Scenarios 02000 32005 02010 02015 M2020 *2025 Figure 5 13 12. In the RJU, the main reforms simulated are the introduction of a minimum age of 53/48 years for men/women at which retirement benefits commence and the elimination of reduced pensions. A contribution rate hike for federal workers and retirees approved by the legislature in early 1999 was struck down later by the Supreme Court. The Federal Government now is trying to amend the rules in order to introduce contributions by federal retirees (most state governments already levy such contributions, but are vulnerable to legal challenges if the Supreme Court ruling stands). The Hauly Amendment to this bill also seeks to extinguish the RJU altogether by mandating that all new hires belong to the RGPS. 13. Simulations indicate that even if the increased contribution rates had While the been approved, the effect of these changes would have been to slow down, federal but not eliminate, the growth of fiscal deficits in the Federal RJU. Without govemment the reforms, for example, the deficit reaches 2.3% of GDP-from the current avs an annual 1.5%-in 2015; if implemented, the reforms would have pushed this date lo Pay an anua 2020. Including subnational RJUs as well would likely double these figures. subsidy of 100 Figure 6 shows the relatively modest gains if the government manages to reais for each introduce an 11% contribution rate for retirees in 2000. Simulations also private sector show that the retirement ages proposed by the government (53 and 48 retiree in the years for men and women respectively, rising gradually to 60 and 55 years) Regime Geral, have little immediate effects on system balances at the current statutory replacement ratios of 100%. The effects of the Hauly amendment were not the subsidy Is simulated, but its main effects are predictable: given the relative youth of 17,500 reais- current govemment workers and retirees, the beneficial effects of the Hauly or three times amendment will not be felt for at least another generation, though the per capita subnational governments will start to experience a loss of revenue right income of away (because the new workers and their employers would have to Brazil-for every contribute to the [NSS). person retiring Completed and Contemplated Reforms of the RJU Result in Little or No under the Fiscal Saving Federal Regime Juridico Unico (0.5) (1.5) (2.0) (2.5) (3.0) Federal RJU Base Case Federal RJU 1998199 Federal RJU 11% on Reforms (Amdt 20) Benefciaries Simulation Scenarios 0 2000 E32005 &a2010 02015 E 2020 *2025 Figure 6 14 Lowering actuarial imbalances 14. Fiscal and actuarial balance are often treated as identical by commentators on social security reform in Brazil. In fact, it is unlikely that fiscal and actuarial balances ever coincide. Fiscal balance in a PAYG system occurs when total contribution revenues match total pension benefits being paid; actuarial balance relates an individual's expected benefits to the same individual's past contributions. Elements affecting fiscal balance include the number of contributors and pensioners, and - contribution and benefit rates. What does not enter into the fiscal balance is the relationship between benefits collected by any one pensioner and High what he/she paid as contributions in the past: the contributions paid in the replacement past were revenue then and entered previous years' fiscal balance, while rates in the RJU benefits collected today are expenditures out of today's fiscal accounts. and no minimum retirement age 15. Figure 7 shows the effects of the reforms for the principal programs in the RGPS in the RGPS and Federal RJU for male workers (the results for women resultRGn are similar). Note that these numbers are computed using an implied resultin contribution by govemment at twice the rate of RJU participant significantly contributions, to make them comparable to RGPS rates of return. Rates higher rates of of return in both the RGPS and RJU length of service programs fall, but by return in Brazil a smaller fraction for the RGPS. But in general, compared with the rather as compared modest fiscal gains for the RJU, these numbers reflect the relatively with those in the deeper reforms for new entrants as compared with RJU incumbents. RGPS reforms affect both incumbents and newcomers, but rates of return US social fall by less for both relative to those in the RJU. However, RGPS reforms security system are relatively certain (with reforms validated as legal by the judiciary), - while the reforms simulated for the RJU are still speculative in nature. While Reforms Have Reduced Actuarial Imbalance, Especially in the RGPS, the RJU Remains Actuarially Unsustainable 16 1 4 0 Pre Reformn 12 * January '99 Package it 1 0 j *1~~~~~~~~~~~~~~~~~~~~~MI1% on Beneticieades j8 E Fator 4 2 RGPS Unreduced RJU Unreduiced Lo$ RJU Reduced LoS RJUJ Reduced US low & high LOS Spoeil !ncorne Figure 7 1 5 16. The comparison of post-reform rates of return in Brazil with rates of return in the US social security system (see Figure 7 again) reveals how much more needs to be done to bring the Brazilian first pillar systems to actuarial balance, especially in case of the RJU. Statutory replacement rates are graduated between 29% and 62% in the US, depending on the income-level, considerably lower than the uniform 100% rate in Brazil. Higher income-earners in the US may even face negative rates of return: their replacement rate is less than one-third that of their Brazilian counterparts. In Brazil, high replacement rates with no minimum retirement age translate into large actuarial imbalances, even though contribution rates rise with wages and are generally much higher than in the US. For fiscal, equity, Increasing equity and redistribution efficiency, and 17. The third goal of social security reform in Brazil is to improve equity. capital market - One measure of inequity is the difference in the rate of return in different te reformo programs. Within the RGPS, for example, annual rates of return in the the reform of Old Age Program are 15-20%, higher than the generous RJU Special the RJU should Length of Service program. But the average benefit in the Old Age precede any Program is low, and the majority of beneficiaries may indeed qualify for further changes means-tested social assistance. Discrepancies in rates of return between in the rules Old Age and Length of Service are perhaps a better indicator of determining inappropriate classification than of system inequity: the profile of Old Age RGPS benefits Program beneficiaries provides a strong case for considering it a part of social assistance, which for transparency reasons could be funded out of general revenues rather than contribution-based social security. But there may be political economy reasons for retaining this administrative arrangement if it is believed that this increases the chances that these social assistance expenditures will continue to be funded (more on this below). 18. With reforms in the RGPS proceeding at a considerably faster pace than for the RJU, the gap between RGPS and RJU subsidies has grown over the period 1999-2000. It is noteworthy, though, that the most pro-poor component of the RGPS pensions-the Old Age Program-has been protected from cuts. Restricting reform to the Length of Service program in the RGPS-which is primarily urban and male-and protecting Old Age Program pensioners-predominantly rural and female-from cuts has helped to minimize adverse effects on the poor. Passage of the Hauly Amendment will ensure greater equity in the long term, but one of the most effective ways to both reduce inequity and improve the redistribution in Brazil's public spending over the next 5-15 years is to immediately bring about more fiscal and actuarial balance in the RJU. 16 Reducing collateral inefficiency 19. There are two major inefficiencies in the Brazilian labor market, both of which can be traced at least in part to weaknesses in the social security system. First, because of the relative generosity of government pensions, there is little or no mobility from the public to the private sector. Second, the high payroll tax rates levied to finance RGPS benefits (that, together with ad hoc taxes levied to fund social security benefits, add up to about 33% of the cost of labor), and the high general tax rates needed - to meet the pension deficits for government and private sector workers significantly raise the cost of doing business in Brazil's regulated sector. Social secunty taxes are high in Brazil, and are 20. Unlike many countries undergoing fiscal adjustment, government exceeded only workers in Brazil are generally overcompensated relative to workers with by a few similar attributes (such as age, education and experience) in the private European sector. For example, a recent study found that: countries such * a male worker with a high school diploma in the federal judiciary in as Portugal Brasilia gets 50% higher pay, had 80% more job security, and could expect 75% higher pensions, compared to his private sector counterpart. * a female civil servant with 12 or more years of education working in the state administration in Rio de Janeiro would get the same salary, had 70% more job security, and could expect 40% higher pensions. * a secondary school teacher in Sac Paulo's public schools gets 15% lower pay but has 50% more job security and can expect 50% higher pensions than a similar worker in the private sector. Large public-private differences in compensation leave no motivation for govemment workers to pursue possibly more productive private sector careers (this is especially true for low wage workers), and also create unintended incentives to join government service just before retiring to get higher pensions (this is especially true for high wage workers). 21. High payroll levies and weak links between contributions and benefits inherent in a PAYG system-made even weaker by lax administration-result in high labor costs in Brazil's regulated sector, and deepen the divide between formal and informal employment. Figure 8 illustrates that social security taxes are high in Brazil, and are exceeded only by a few European countries in the industrialized world. With reforms taking root in countries such as Argentina and Mexico, Brazil's high tax rates result in lower wages and employment in an increasingly competitive global economy. 17 Brazil has the Highest Payroll Tax for Social Security in Latin America, While Portugal has the Highest Rate Among Industrialized Countries 50.0 45.0 40.0 34.8 35.0- S250 2 B. 20.320.029.6 30.0 30.0 - 8327.5 27.0 o25.0 2020frgvrmn ~~~ 20.0 ~ 0. 2. , 20.0 - _ 1 r16.5 16.012. 15.5 Pension funds 15.0 _ 12Z4 - 14013.5130 1Z 0 for government 10. 9H4 9.0 employees 5.0 should ideally 0.0 not be set up ,zgDE *^i>> rKi°>,!,.* t4*^ goX'before RJU rules are changed, and Figure 8 tax incentives for private poension funds Facilitating expansion of funded schemes are unlikely 22. The limited macroeconomic and fiscal elbow room due to the nature given fiscal and timing of Brazil's stabilization has precluded the setting up of a multi- constraints pillar system with a mandatory funded scheme. But the consensus in Brazil facing is gradually moving towards greater reliance on funded schemes for old age govemment support. This is in line with the experience of other countries. The today government has taken steps to encourage voluntary funded schemes, including a set of well-designed rules for both private and govemment pension funds, and also plans to consolidate and strengthen supervision. But it is unlikely that it can find the fiscal space for tax incentives for individual and employer-sponsored retirement plans until deeper first-pillar reforms are completed. 23. The Federal government has also facilitated the setting up of complementary pension funds for government workers. While risky, this is promising from a political economy point of view: it allows government to offer its employees a "new deal" consisting of lower but more dependable pensions rather than confronting them with the bad news that their benefits will be reduced, and it ensures that privatization proceeds are used to pay down the govemments' debt. To make this lasting solution, however, the govemment must do two difficult tasks before pension plans are created. The first is to take the RJU benefit formula out of the Constitution, introduce a minimum retirement age for current workers, lower replacement rates, and increase the reference period. Under current RJU rules, even large infusions 18 of cash (e.g., from privatization) are quickly dissipated: simulatons for Parana's RJU show that even if a year's revenues of the state government (about R$5 billion) were parked in a pension fund and earned a high rate of return, the funds are used up in five years (see Figure 9). The second is to remedy weaknesses in the regulatory and supervisory system. Without RJU Reforns, Even Pensions Funds Started Wkth 100% of a State's Annual Revenue Are Depleted in Five Years 18 16 + _ For most states,. even puffing one 14 / t 200o -X-3_% year's total i=5 12 2 \ ~~~~~~~~~~~~~revenues into a ; 10 pension fund e 3c cannot finance state pension 06 expenditures for more than five 2 I. *^ - \ \years Figure 9 19 III. THE POLICY INEVITABILITIES 24. To attain the goals stated above, Brazil has little choice but to reduce subsidies for government pensions by lowering replacement rates, lengthen the reference period for calculating pensions in the RJU, institute a minimum retirement age in the RGPS; have greater funding of pension liabilities and, eventually, reduce payroll tax rates. While exacerbating public-private inequity, recent RGPS reforms are an important step towards improving fiscal balance and efficiency. The fiscal burden of public pensions and growing gap between RGPS and RJU pensions should be publicized using a strategic communications campaign to generate support for continued reform among those who stand to gain the most from it-the youth, private sector and the poor. The key to Subsidies for government pensions have to be reduced effective reform 25. All the findings of this report indicate that there is no recourse other than of social security to quickly reduce the subsidy for pensions of government workers that is is widening the projected to double in magnitude by 2005, even after a generous government- debate to as-employer contribution of 20% of payroll is imputed: include potential * Fiscal reasons - RJU fiscal deficits are more than twice those in the winners from RGPS, and this would not have changed for another ten years in the these changes - absence of reforms. With the latest reform of the RGPS benefit formula, especially the RJU deficits will remain greater than RGPS deficits. p P cY * Equity reasons - On a per beneficiary basis, the federal government pnvate sector, "subsidy" to the RGPS is less than 5% of the subsidy to RJU retirees. the young, and Without reform, this rises to 15% by 2025, but the absolute gap in the the poor subsidy grows five-fold to R$80,000 and, with the latest RGPS - reforms, this gap will rise considerably. * Efficiency reasons - While the high payroll tax that finances RGPS benefits distort the labor market, high general taxes required to fund the larger RJU deficits may be as distortionary as the INSS levy. * Saving-related reasons - Though the saving and capital market development rationale for pension reform is unproven, conditions in Brazil indicate that better fiscal and actuarial balance in first-pillar pensions-especially the RJU-will allow the fiscal headroom for fostering sustainable growth of the third, funded pillar. Replacement rates have to be lowered 26. The simulations conducted in this report, while not providing failsafe quantitative projections, provide reliable measures of relative effectiveness of policy measures. The results show that replacement rates in the RJU have to be lowered for making any sizeable gains on the fiscal, actuarial, and equity fronts: * Raising contributions - Increasing contribution rates is not sufficient even for actuarial balance at rates of replacement nearing 100%; for fiscal balance, contribution rates of greater than 50% are required which 20 are neitherpolitically feasible noreconomically desirable. Estimates show that only marginal improvements in equity would have resulted in the Federal RJU from the higher/graduated contribution rates of 11-25% struck down as unconstitutional in 1999. * Reducing evasion - Reducing evasion is difficult at current high contribution rates, but simulations show that even eliminating evasion does not restore actuarial balance; at the high replacement rates and easy eligibility conditions, increasing coverage would have worsened fiscal balance. The fator previdenciario addresses this shortcoming. * Increasing time of contribution - The elimination of reduced pensions _ was shown to help in the short term, but-at the high replacement rates existing at the time-this measures may have actually worsened the There is no fiscal balance in the RGPS over the medium to long term. The fator recourse for previdenciario addresses this shortcoming effectively. Brazil but to * Instituting a minimum age of retirement - Our simulations indicate that lower the high, the fiscal gain to having the proposed retirement age of 60/55 years uniform for men/women is modest but measurable in the short-term. But while this measure will help in improving actuarial balance considerably replacement and delay retirement, there appears to be no political appetite for rates- instituting this eligibility condition for the RGPS. experience International experience suggests rules for sustainability and equity: suggests that replacement rates of 30-40% for high wage earners (with voluntary pensions as rates higher a supplement if desired) and 60-70% for low wage earners (with social than 40-70% assistance to supplement as needed). It is necessary to remove the benefit cannot be formula for RJU pensions from the Constitution, as done for the RGPS in 1998. suta d For those already retired, it is reasonable-in the absence of a minimum ustaine retirement age-to expect the same rate of contribution as for those still working, otherwise the effective replacement rate is higher than 100%, providing a harmful incentive to quit working and contributing early. And the rule for benefit indexation can then be changed from salary levels to price indices. The reference period has to be lengthened uniformly 27. Increasing the reference period from the current last month for the RJU and last three years for the RGPS will yield fiscal, equity, and efficiency benefits, but especially if done uniformly for both regimes. * Fiscal gains - Since most workers earn the highest salary at the end of their careers, an end-loaded replacement formula (last 36 months in the RGPS and last month in the RJU) implied a higher pension expenditures than would result if the entire working history is taken into account in calculating pension levels. The recent change in the RGPS benefit formula to increase the reference period to almost the full working life will increase labor market efficiency. It also raises INSS revenues because workers lose if they underreport earnings, as is the current practice. * Equity gains - Age-earnings profile of educated (i.e., wealthier) workers are higher and steeper while a 60 year old educated man earns three 21 times the salary of a similarly schooled 25 year old man, this ratio is only 1.5 for less educated workers. Extending the reference period to the working life would remove pro-rich biases in the formulas of both RGPS and RJU, but-because RGPS pensions are capped at R$1255 per month and RJU pensions are not-especially for govemment pensions. Efficiency - Labor market efficiency will improve most if the increases in the reference period are uniform for both the RGPS and RJU. The recent changes in the RGPS benefit formula accomplish this objective for private sector social security. For the greatest fiscal, equity, and efficiency gains, it is necessary to remove the RJU benefit formula from the Constitution, lower the replacement rate for current workers, change the rule of indexation from nominal salary to inflation, and increase the reference period so that the rules are the same in both the RJU and the RGPS. For fiscal, efficiency, and A minimum retirement age has to be instituted labor market 28. A minimum age at which benefits commence has to be introduced for reasons Brazl RGPS retirees. While the fiscal gains from this measure may be modest in the should short term as the retirement age is phased in, this step is critical for labor market eventually lower efficiency reasons, viz., signaling that pensions are for old age support and not contribution as an additional source of income while individuals are or should be working. rates for funding Simulations show, however, that the retirement age must be at least 60 years to its mandatory be effective. Work-life differences and labor force participation differences socialsecunt between men and women may provide some rationale for having shorter soral ty length of contribution requirements for women, but life expectancy stafistics programs to suggest that the retirement age should be the same for men and women. about 15-20% Funded pensions have to grow in importance 29. For both fiscal and risk diversification reasons, the coverage and size of the funded pension system must grow in Brazil. Over-reliance on first-pillar pensions has resulted in political pressures culminating in adverse fiscal, equity, and efficiency outcomes. Sustainable growth in funded schemes has three major prerequisites: balanced and clear legislation, a skilled supervisory body, and actuarially balanced first pillar pensions, especially for government workers. Taxes to finance first pillar have to be lowered eventually 30. Though tax rates cannot be lowered until pension benefits are lowered, it is important for planners to not assume that combined employer-employee rates of 30-35% of the salary bill are reasonable. This appears to be the case today: the maximum allowed ratio of pension deficit to net revenues of 12% at all levels of government is based on this arithmetic. International experience suggests that sharp increases in evasion occur at rates around 15% of payroll. Brazil's own experience suggests that rates higher than 15% are not politically feasible for govemment workers. The long term goal should be employee contributions of 7-10%, with at most matching employer contribution rates. 22 IV. OTHER POLICY CHOICES 31. While the last section discussed reforms that Brazil will in all probability have to make, this section suggests some changes that will help but may not be strictly necessary. These are to make the PAYG components of social security minimalistic, to integrate the RJU and RGPS, to rely on either mandatory or voluntary funding, and to separate contributory from noncontributory social security. First-pillar pensions could be kept minimal 32. Having a well-run minimalist PAYG pension pillar that aims to provide a floor below which living standards do not fall for the elderly and While both the disabled has many attractive features, especially that it minimizes the theo, and distortions associated with defined benefit schemes such as the RGPS or .the and RJIJ. Three changes are required for the Brazilian first pillar to be regarded practce suggest as well-run and minimalistic: tightened administration of the INSS, lower that Brazilians benefits, and a graduated replacement structure that pays a higher fraction should rely on of reference wages to those with lower incomes. Such a scheme provides a more than one societal safeguard against poverty of the elderly by being inherently pillar of old age redistributive, protects governments from moral hazard by being frugal, security, and shields individuals from myopia by requiring mandatory contributions e nce does towards old age security. The size of the first pillar is fundamentally a expeen societal decision-Brazil may choose to have a more generous one and pay not clearly a higher price in fiscal and efficiency terms. But there is no justification for indicate that a having one that is weakly administered and highly unequal. mandatory RJU and RGPS pensions can be integrated funded pillar is necessary 33. Equity and efficiency-related problems facing Brazil's social security - wciuld perhaps be best addressed by merging a reformed RJU with the RGPS, essentially reverting to the pre-1988 situation. The Hauly Amendment proposes to do just this over the long term. A majority of countries maintain separate systems for govemment workers, so Brazil would not be an exception if it continued with the current two-part first-pillar system. But almost 40% of countries surveyed recently-such as Argentina and the US-have begun merging these components. The US Federal Employees' Retirement Scheme was introduced in 1986, and today many federal government workers rely on the national social security system for the basic pension, to which the federal government contributes on their behalf just as would a private employer. Their pensions are augmented by closed pension plans, which the federal government oversees as would any private firm with an employer-sponsored pension scheme. Employees in many states in the US and Argentina also belong to the national social security systern, as is the case for smaller municipalities in Brazil. With good design and strong supervision of employer-sponsored pension plans, this design offers the most occupational flexibility. 23 Third-pillar growth may make second-pillar unnecessary 34. With its high rate of informality and early average retirement age, Brazil can benefit from the labor market advantages of having a funded pension scheme. These include stronger links between contributions and benefits that reduce the motivation to evade, reductions in the pure tax component that lower the cost of labor, increased mobility because pension rights are portable, and reduced incentives to retire early. But not too much should be expected from the creation of a funded system. In Chile, where a funded system has been in operation for almost two decades, informal sector employment has remained at about 50%. Brazil's own experience with the FGTS-also a funded payroll-tax-financed scheme-again provides Not too much cause for cauton. The causes of informality in Brazil may lie also with the should be manner in which labor legislation is enforced, with people with unsigned expected-in contracts receiving similar protection under the law as that afforded to those terms of with formal labor contracts. In light of this, there are few labor-market- reduced related reasons for government to mandate a funded component. Keeping u the first pillar small and having a well-regulated voluntary pillar may well be in mality- sufficient for Brazil, just as it has been for the US. from increased funding of pensions, Assistance to elderly poor could be better targeted especially given the high tax 35. Approximately 6 million persons, or 33% of the pension and survivor rates on benefit recipients under the Regime Geral, are rural men/women who have economic little proof of service, but can prove that they are at least 60/55 years old. activity and the The average level of these benefits is R$137, just one real more than the legally specified minimum monthly salary until mid-2000, and sum up to mannerin which about R$8 billion annually, i.e., roughly the size of the RGPS deficit in 1998. Brazil's labor By all accounts, a large share of this sum goes to the elderly poor; by one laws are account, these transfers are between 10-15% of the GDP of the poorest enforced northeastern states such as Maranhao and Piaui. 36. There are several good arguments to support replacing the contributory pensions received by rural households with targeted social assistance. The poverty impact and welfare benefits cited in Volume II would be attained, and perhaps increased if the current contributory old age pensions program were a social assistance program with a secure, more broadly-based source of revenue. As a social insurance system, the old age pension system fails on actuarial and fiscal grounds. And while it succeeds in redistributing income from urban to rural workers, the net impact on income distribution in rural areas is unclear-largely because the incidence of contributory social insurance and non-contributory social assistance cannot be analyzed separately. Additionally, retaining the old age benefit as contributory social assistance may provide workers with strong incentives to strategically abuse the RGPS. Recent reforms to the 24 RGPS length of service program tighten pension benefit-to-contribution linkages, and cut replacement rates. Current length of service contributors thus have an incentive to opt for benefits under the old age system, undermining the fiscal sustainability of the reforms. The lenient eligibility requirements for an old age pension extended to rural workers increase the potential for strategic abuse. Separating the social insurance system from the social assistance funcfion might be beneficial even if both continue to be administered by the same agency, preventing cross-subsidies from one to the other, and allowing the government to target poverty relief at one group with fewer disincentives for the other. The decision on 37. On the opposite side of the argument, separating the public pensions whether or not received by rural households from the mainstream social security regime to separate may leave the program without a political constituency to defend it, and contributory make public benefits for the rural elderly vulnerable to large budget cuts by from future govemments that are under pressure to reduce spending. noncontributory Additionally, eliminating the contributory component of the old age pension nsin should benefit-however symbolic or nominal this may be-may trap poorer penso s workers in a marginalized social program with no mechanism and hence be made incenfive for eventually graduating into the general pension system. keeping in mind the complicated 38. In a country where it has been difficult to make government political expenditures poverty-focussed, rural pensions are exceptional and should economy of be protected from cuts during the reform of the RGPS. While this social noncontributory segment is obviously being funded with general revenues assistance, not from the Treasury instead of earmarked contributions collected by the INSS, solely on the it may not serve Brazil well to institutionally transfer this program to the basis of fiscal or Secretariat of Social Assistance. While this decision is perhaps best made administrative by those who understand both the administrative implications of these considerations options and the complicated political economy of welfare programs in Brazil, the recommendation of this report is to keep it bundled with a system that has widespread voter interest. Hence it should be left under the INSS, but the Ministry of Social Security should sponsor a thorough evaluafion of the Old Age program to make it even better targeted to needy groups such as the rural poor, for whom currently there are few other welfare options. 25 V. SUMMARY AND CONCLUSIONS 39. Social security is the single most important fiscal issue facing the federal and subnational governments in Brazil today. The overall pension deficit was about R$40 billion in 1998, or more than 5% of GDP. When the interest payments on public debt accumulated on behalf of public pensions are included, this ratio doubles to 10% of GDP. The criteria for evaluating reform measures 40. There are many compelling reasons for reform of social security in _ Brazil including equity, labor market efficiency, and savings and capital market development, but fiscal concerns are correctly viewed as paramount. Despite facing Accordingly, in evaluating whether or not a proposed measure is consistent with formidable the constraints and objectives of Brazilian social policy, this report suggests five legislative, criteria-in order of importance-for evaluating any reform strategy or judicial, and measure: other obstacles, 1. Immediate fiscal payoff, the Government 2. Long-term fiscal sustainability, has actively 3. Equity considerations, especially RGPS versus RJU, pursued social 4. Efficiency considerations, especially labor market distortions, and security reforms 5. Savings and capital market development impact. since 1997 and has achieved considerable The progress made success 41. The obstacles to reform are well-known and formidable, having legislative, judicial and executive dimensions. Despite these obstacles, the Federal Government has actively pursued reform since 1997. Even in the midst of the 1998 national elections-never an easy time for governments to renegotiate social contracts with voters-the Federal Government kept up the momentum for reform. Constitutional reforms were approved in November 1998 and other measures-notably increased contributions from RJU participants- were attempted in 1999. The main reforms are: * RGPS: Modest short-term fiscal relief through increased eligibility requirements but significant medium-term and long-term fiscal gains due to new benefit formula that lowers replacement rates and lengthens reference period for calculating pensions; the introduction of the benefit formula also sends a clear signal that the government is serious about using the space cleared by earlier constitutional amendments. RJU: Relatively modest fiscal relief due to increased eligibility requirements, mainly a minimum length of public service and time in job 26 from which retirement takes place, and phased in age of retirement; main systemic change would be a clause invoking automatic employee contribution increases if the pension deficit exceeds 12% of net current revenues at any level of government. SCP: Major improvements can result if rules marking a shift to defined contribution plans with lower employer contributions are implemented, and entties other than enterprises (such as professional groups) are allowed to set up closed pension funds. The challenges ahead 42. The principal challenges are to reduce the generosity of both RGPS and Sustainable RJU pensions while keeping a safety net element, reduce differences between reform of the RGPS and RJU pensions, and encourage sustainable growth of funded plans by complex paring down RGPS and RJU (unfunded) pensions and by strengthening Brazilian social regulation. The reform of a complicated social security system such as that of security system Brazil under the fiscal, administrafive and political constraints that it faces must under the be viewed as a step-by-step process, with the sequencing determined both by strategic and tactical considerations. Table I presents the steps that would be constraints consistent and inconsistent with the long-term goals of a sustainable, effficient, faced by the and just social security in Brazil. Table 1 also summarizes these goals. The country may be steps consistent with these goals would be: best - Reduce RJU fiscal deficits: The main reforms needed are reduction of accomplished statutory replacement ratios from current 100% for fiscal and equity through a series reasons, and increasing the reference period from the last salary to the full of measures working life; both require amending the Constitution, the urgency of which whose will be better appreciated through revelation of imbalances through actuarial sequence is audits of federal and state RJUs and open discussions (see Table 2 for d details). Having retirees contribute at the same rate as active workers helps determined by on fiscal, equity and efficiency grounds, but should not be considered the tactics as much primary measure for restoring balance. as strategy * Control growth of RGPS deficits and improve redistribution: The first priority should be the administrative strengthening of the Ministry of Social Security, especially the INSS. The main design-related reform needed is a retirement age of at least 60 years; this would require a constitutional amendment). Fiscal and efficiency gains from the recent reform of the Length of Service program's benefit formula depend critically on the administrative capacity of government to prevent leakage to other programs, especially the Disability and Old Age programs. Other implementation- related steps involve maintaining the rural old age pensions program but refining its administration to lower fraud (see Table 3 for details). * Increase pension fund coverage: The main reforms needed are better supervision of employer-sponsored plans and friendlier tax treatment of individual retirement accounts (see Table 4 for details); employer-sponsored 27 plans should be set up under similar rules as for in the private sector, but after current RJU rules are changed through negotiations with government employees, preceded by strategic communicatons to inform the electorate of the benefits from social security reform (see Table 5 for details). - The unfaimess 43. Reforms of the RJU should now take priority over further changes in the of reduced design of the RGPS. RJU reform will undoubtedly be politically challenging. To RGPS pensions facilitate these reforms, the adverse equity effects of completed RGPS reforms hot I without reducfions in the generosity of RJU pensions should be widely withou simiar publicized to generate grassroots support for comprehensive reform of the RJU. reductions in the Pension funds for state pensions, or introducing a funded component in generosity of pensions of Federal government workers can be a facilitating factor for making government RJU reform politically palatable, but-given that all pension systems are already pensions should in deficit even with high rates of contribution-do not constitute a feasible reform now be widely strategy on their own. There are few convincing reasons to liquidate taxpayer- bli d t financed government assets in order to confinue paying unsustainably high pubicize o pensions to a relatively small group of economically privileged government generate workers, after having reduced pensions for otherwise similar workers who just support for happen to work in the private sector. deeper RJU reform X)O(oX 28 Table I THE OBJECTIVES OF SOCIAL SECURITY REFORM, AND MEASURES CONSISTENT AND INCONSISTENT WITH THESE GOALS Objective Steps Consistent with Objective Steps Inconsistent with Objective Fiscal balance (1) Structural reform of RJU, along the (1) Not increasing the reference lines of RGPS reform period for the RJU. (2) Longer reference period in RJU, (2) Introduce reserve funds for along the lines of RGPS reform government workers--allowing states (3) Minimum retirement age in both to move pensions off-budget-without regimes first reforming the RJU. Equity (1) ) Increase reference period (1) Pay past dues of INSS to state uniformly for RJU and RGPS and municipal RJUs to keep paying (2) Introduce graduated replacement unsustainably high RJU pension rates, with lower ratios for high wage benefits earners. (2) Use privatizaffon proceeds to pay (3) Higher contribution rates for RJU unsustainably high RJU benefits. retirees and workers (3) Maintain special regimes for (4) End all special regimes, except for primary and secondary school few risky occupations teachers in PAYG component (5) Have a lower time of contribution for (4) Have lower age of retirement for women, but the same age of women. retirement (5) Restricting funded component (6) Merge federal, state and municipal only to high wage eamers. RJUs with RGPS Redistribution and (1) Introduce graduated replacement (1) End rural old age pensions, or safety net rates, with lower ratios for high wage making rural pensions susceptible to earners. budget cuts by separating its (2) Continue rural old age pensions administration from contributory (3) Make first pillar "minimal" pensions Actuarial balance (1) Extend reference period for PAYG (1) Restricting funded component components to entire working life only to high wage earners. (2) Make all funded components defined contribution (DC) Labor market (1) Merge federal, state and municipal (1) Raise INSS payroll tax rates efficiency RJUs with RGPS (2) Raise share of employer (currently (2) Reduce employer to employee 20%) in payroll tax payroll tax ratio, currently 2:1 in the (3) Index to salary levels RGPS and RJU (4) Reform RGPS further without also (3) Introduce retirement age of at least reforming RJU 55-60 years in RGPS. (4) Indexing to inflation Savings and long- (1) Stronger regulation of private funds. (1) Have separate agencies for term capital markets (2) EET rules for open funds regulating open and closed funds. development (3) Reduce first-pillar benefits. (2) Introduce reserve funds for (4) Convert the FGTS into a mandatory government workers without first retirement plan. reforming the RJU. ___________________ __________________________________ (3) Raise first pillar benefits. 29 Table 2 THE REGIME GERAL DA PREVIDENCIA SOCIAL: PROBLEMS, BEST PRACTICE, AND POLICY RECOMMENDATIONS P;rblemr Diagnosis Best Practice Policy Recommendation Lenient eligibility, With no minimum Individuals in most 1. Establish a minimum with no minimum retirement age, the countries spend twice or retirement age at which age of retirement result is equal periods three times as long retirement benefits of time contributing and contributing as receiving commence; while the "fator receiving benefits. pensions. Minimum previdenciario" lowers retirement age of about benefits for early retirees, it 55-60 years is key factor does not eliminate the in inducing this behavior. need for a minimum retirement age. High benefits The Constitutional Mandatory benefits of 2. Lower first-pillar benefits Amendment of 1998 30-50% of average wage to replace a fraction of makes the replacement are more likely to be average lifetime eamings, rate 100% of gross fiscally sustainable accomplished to a wage, well above 100% without huge labor significant degree by the of net wage. market distortions. new benefit formula 3. Diversify the burden and risk of income security in old age to multiple pillars High evasion Contribution rates are Contribution rates not 4. The new benefit formula about 30%/o and pension much above 15% lead marks a move toward is based on last 36 to lower evasion. lifetime earnings for months' salary, leading Countries moving toward calculating pension; to underreporting of using lifetime earnings however, diversifying into earnings. for determining pensions. multiple pillars would allow lower mandatory contribution rates. Multiple receipt of It is possible to Internationally, 5. Eliminate multiple benefits complete requirements individuals receive only benefits; the new benefit for both length of one pension: old age, or formula requires stronger service and old age disability, or as survivors. control against workers pensions and receive switching to relatively two pensions. lenient Old Age pensions and Disability benefits. Contributory Old age program - Social assistance and 6. Old Age program should system functions especially rural social insurance are probably not be separated as social pensions - serves as a generally separated, so from social security and assistance valuable social that unintended should be retained under system assistance system, but redistribution is the first pillar to ensure at a cost to contributory minimized. political resiliency, but pensions. 7. Its targeting to elderly poor could be improved through rigorous evaluation and reform of delivery mechanisms.. 30 Table 3 THE REGIME JURIDICO UNICO: PROBLEMS, BEST PRACTICE, AND POLICY RECOMMENDATIONS Problem Diagnosis Best practice Policy Recommendation Generous RJU has highest Trend toward funded 1. Reduce replacement rates. benefits statutory replacement plans, and integration 2. Institute ceiling on first-pillar rates in the world, into national first-pillar benefits from the RJU, aligned combined with least systems. If stand-alone with RGPS. demanding vesting regime is maintained, 3. Reliance on funded plans rules. benefits are aligned with for retirement income above _____________private sector pensions. the first-pillar ceiling. Indexation to Makes RJU pensions Trend towards indexation 4. Index benefits to inflation. current salary generous and results in of pensions to changes in of post from productivity-increasing some price index, or an which retired reform being costly. index combining salaries and prices. End-loaded Basing benefts on last Benefits based on 5. Reference salary based on benefit formula month's salary average lifetime 80% highest salaries, just like increases abuse and earnings. the RGPS. public-private inequity. 6. Replacement determined by accrual per year of service. Loosely Many current retirees Vesting requirements 7. Vesting periods aligned with applied vesting became vested under should be uniform in first- the RGPS. requirements the RJU after 'last pillar systems and strictly 8. Full transfer of acquired minute" migration into enforced. rights and of contribution govemment service. revenue between regimes. Early Government workers No first-pillar benefits 9. Establish minimum age at retirement and have incentive to retire before a minimum age. which benefits commence. no restrictions early to receive a Actuarial penalties for 10. Actuarially fair reductions on benefits stream of tax- and early retirement. in benefits for early retirement. upon re- contribution-exempt Restriction on multiple 11. Restrictions on multiple employment income. pensions and reduced benefits, and reduced benefits benefits if employed. from first-pillar if employed. Special Special vesting rules for Uniform first-pillar vesting 12. Eliminate remaining retirement teachers contribute to and benefit parameters. special regimes. schemes RJU deficits. Salaries in public sector 13. Establish uniform vesting Compensating low-paid aligned with private and benefit parameters within teachers with generous sector. Compensation for first pillar pensions. pensions is inefficient. 'difficult" jobs made as 14. Increase teacher salaries higher salaries and not in public schools to parity with as higher pensions private sector. Inequity The RJU directly First-pillar generally 15. Strategic communications between first- contributes to income provides only a minimum campaign to draw attention to pillar systems inequality, and leads - benefit. Tax-financed first-pillar inequities. through fiscal instability replacement rate does 16. Integration of RGPS and and reduced economic not exceed 3 times the RJU and/or cut in first-pillar growth - to higher contribution rate. First- benefits. poverty. pillar is safety net; second 17. Strong supervision and and third-pillar provide regulation of third-pillar SCPP bulk of pensions. and creation of second pillar. 31 Table 4 PENSION FUNDS FOR PRIVATE SECTOR WORKERS: PROBLEMS, BEST PRACTICE, AND POLICY RECOMMENDATIONS Problem Diagnosis Best practice Policy Recommendation Restricted Maximum benefit in RGPS Most OECD countries 1. Supervisory agency to coverage is R$ 1,255 per month, do not have eligibility ensure that plans are offered used by companies as a constraints related to to all employees, regardless break point for contributing salary level. of salary level. to complementary system. Uncertain tax Government has Most OECD countries 2. Commitment to EET treatment maintained a dispute with have EETtaxation. taxation, where contributions pension funds over the and fund earnings are need for EET taxation. exempt, but benefits are taxed. High Operational costs in closed Not identified, but well 3. Evaluate causes of high administrative funds (employer-provided, regulated and administrative costs among costs mainly DB) higher than in supervised employer closed funds. Chile (individual, only DC). pension plans should 4. Eliminate 6% minimum High fees of open funds, in principle have much return rule in open funds, or often above minimum loweradministrative 5. Ensure comparability return of 6%. costs than individual between plans and pension plans. transparency Inadequate No vesting and portability The Netherlands for 6. Update regulatory regulatory rules, low funding and vesting, portability, framework, as envisaged in structure auditing standards, weak funding, auditing, and proposed complementary sanctions, poor investment disclosure standards. legislation. rules, distortionary Netherlands and Chile minimum return rules, for valuation and limited disclosure. diversification rules. Ineffective Duplicated supervisory The Netherlands, and 7. Integrate closed and open supervision roles in SPC and SUSEP. the newly created fund supervisory agencies Understaffing and lack of independent agencies into one. autonomyof SPC. Weak in Latin American 8. Ensure administrative, supervision and low countries such as functional, and financial information requirements of Argentina and Mexico. autonomy of new supervisory pension funds. agency. Notes: 'EET" signifies a tax regime where contributions and fund eamings are exempt, but benefits are taxed. DB is the acronym for defined benefit pensions, where the benefit level is determined by length of service and salary levels. DC is the acronym for defined contribution pensions, where the benefit levels are determined by the contributions made by and on behalf of the individual, and the investment returns on these funds. SPC is the Secretariat of Complementary Pensions in the Ministry of Social Security, which regulates closed or company-sponsored pension plans. SUSEP, in the Ministry of Finance, is the supervisory agency for other funded pension plans, insurance companies. OECD is the Organization for Economic Cooperation and Development. 32 Table 5 PENSION FUNDS FOR GOVERNMENT WORKERS: PROBLEMS, BEST PRACTICE, AND POLICY RECOMMENDATIONS Problem Diagnosis Best practice Policy recommendation Lack of Civil servants' plans (RJU US FERS consists of 1. Integration of at least a diversification and pension funds) are three mandatory parts: major component of the of sponsor risk administered by the same national social security, a RJU plans with the RGPS. and limited risk- entity, the sub-national DB pillar administered by pooling in RJU govemment. the government, and a plans. funded DC pillar managed by mutual funds. Imminent Pre-funding pension Fully-funded systems with 2. Creation of pension fund depletion of liabilities is not viable viable contribution and should be conditional on fund reserves. unless drastic parametric benefit structures, such as adequate parametric reforms are carried out in the FERS and most state reforms. the RJU. pension plans in the US. Inefficient If both the basic plan and The Netherlands has an 3. If DB, integrate basic and administrative complementary plan are integrated supervisory complementary plans into a and supervisory DB plans, there will be a structure for all employer single fund, regulated by structure of two duplication of pensions and individual supervisory agency of component, administrative and insurance plans. complementary pension two-fund, DB supervisory functions. Parana has proposed a system , or plan. single-fund DB plan 4. Funded plans to be only subject to a single set of defined contribution. regulations. Lack of RJU plans fall outside the Parana is moving in the 5. Full RJU plan - not only adequate jurisdiction of the federal right direction, wih a law complementary part - regulation and government: no guarantee that calls for full funding, should be supervised by external that states will have full- and establishes a agency regulating supervision of funding of RJU plans, or governance structure complementary pensions. RJU (reserve adequate governance for for the reserve fund 6. If this is not possible, Law fund) plans. reserve funds to mitigate similar to that of closed 9717 should refer to the political interference. funds in the federal complementary pension law, complementary system. or states should introduce the same laws. Complexity and DB plans are more difficult No country has dealt 7. Establish a significant inadequate to regulate than DC plans, adequately with state's component of RJUs as a DC regulation of and lead to controversial intrusion into corporate plan. government - issues like corporate governance of private 8. Regardless of the size of sponsored DB governance of private firms; ownership control the DC component, pension plans. firms. DC plans ensure limits (on the share of regulatory framework and benefit-contribution links, company equity that any capacity of complementary and allow portability. fund can hold) mitigate pension agency must be this problem somewhat. improved. Notes: FERS is the US Federal Govemment Employees Retirement Scheme, introduced in 1986. DB is the acronym for defined benefit pensions, where the benefit level is determined by length of service and salary levels. DC is the acronym for defined contribution pensions, where the benefit levels are determined by the contributions made by and on behalf of the individual, and the investment retums on these funds. 33