Features

Privatization works

National | To reform Social Security? Take a look at Chile's success

Issue: "Social Security," Jan. 11, 1997

A federal advisory panel established more than two years ago to consider ways in which the Social Security system might be revamped to meet the needs of the baby boom generation has been unable to reach an agreement.

Six of the 13 panel members oppose the most important changes that would transfer power from the state, labor unions, and special interests to individuals. These, predictably, include members with close ties to Democrats in Congress and three union representatives whose influence would be diminished if Social Security were made private.

What the panel and all Americans should seriously consider is the 15-year-old system in Chile. It is described in an interesting essay by Jose Pinera for the Cato Institute called "Empowering Workers: The Privatization of Social Security in Chile."

We see you’ve been enjoying the content on our exclusive member website. Ready to get unlimited access to all of WORLD’s member content?
Get your risk-free, 30-Day FREE Trial Membership right now.
(Don’t worry. It only takes a sec—and you don’t have to give us payment information right now.)

Get your risk-free, 30-Day FREE Trial Membership right now.

In 1980, the government of Chile scrapped its government-run pension plan and began a national system of Pension Savings Accounts (PSA). Fifteen years later, pensions in the new private system are 50 to 100 percent higher than under the old pay-as-you-go system, depending on the type and level of benefits. Because the money from workers is invested privately, Chile's economy has grown from the historical 3 percent to 6.5 percent on average. Furthermore, the savings rate has increased to 27 percent of GNP and the unemployment rate decreased to 5 percent since reforms were implemented.

The American Social Security system is the largest single government program in the world. It spends more than $350 billion a year, which is more than our defense budget during the Cold War. Everyone acknowledges there are problems, but power is not easily relinquished by those who have it. Any meaningful reform will take enormous pressure from the public, and this will come only when we understand the significant benefits in a privatized retirement system.

Under Chile's PSA system, neither the worker nor the employer pays a social security tax to the state. Nor does the worker collect a government-funded pension. Instead, during his working years, he automatically has 10 percent of his wages deposited by the employer each month in his own PSA. The percentage applies only to the first $22,000 of annual earnings. Therefore, as wages increase, the "mandatory savings" content of the pension system goes down. A worker may contribute an additional 10 percent of his wages each month. All contributions are tax deductible.

A worker chooses one of the private Pension Fund Administration companies to manage his money. These are regulated by separate government agencies and invest money only in low-risk securities. Each worker gets a PSA passbook and receives regular statements showing the performance of his investment fund. The old one-size-fits-all scheme was replaced with a system tailored to individual needs. Taxes are paid when funds are withdrawn according to one's tax bracket at the moment.

A worker who has contributed for 20 years, but whose pension fund upon reaching retirement age is below the legally defined "minimum pension," receives that pension from the state once his PSA has been depleted.

Two other significant changes contained in Chile's PSA system: First, Chilean workers can keep working after "retirement." If they do, they receive their pension and they are no longer required to contribute to the plan. Second, workers with sufficient savings in their accounts to fund a "reasonable pension" (50 percent of the average salary of the previous 10 years, as long as it is higher than the "minimum pension") may choose to take early retirement whenever they want.

The pension is portable, since it is not tied to any one company, thus eliminating the problem of "job lock."

As for a transition between the old and new system, Chile employed three basic rules:

- The government guaranteed those already receiving a pension that they would be unaffected by reform unless they chose to enter the new system (90 percent did).

- Every worker already contributing to the pay-as-you-go system could choose between staying in that system or moving to the new one. Those who left the old system were given a "recognition bond" that was deposited in their new PSAs.

- All new entrants to the labor force are required to enter the new system.

The benefits? Workers make more money because the old employer retirement contribution now goes directly to the worker. Economic growth in Chile has been so strong that the country now runs a fiscal budget surplus, fueling economic growth and spurring the development of efficient financial markets and institutions. And, best of all, the average real return on investment has been 13 percent per year, more than three times higher than the anticipated yield of 4 percent.

Comments

You must be a WORLD member to post comments.

    Keep Reading

     

    Phoning it in

    Tests via smartphone may soon challenge traditional methods

     

    Goal keeper

    Ryan Hollingshead put pro soccer on hold to pursue…

     

    Pain and gain

    Experience, including tragic experience, has made Rick Warren a different…

    Advertisement