Itaú BBA - FAQs: Social Security Reform (PEC 287)

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FAQs: Social Security Reform (PEC 287)

December 12, 2016

The reform is necessary, given the aging of the Brazilian population.

The Brazilian government recently sent to Congress a Social Security reform proposal (PEC 287), the next step in the structural fiscal adjustment that began with the spending cap amendment. This report answers some frequently asked questions about the proposal, which would unify and streamline the rules governing Social Security benefits in Brazil and will be debated in Congress throughout the first half of 2017.

1. What is the Social Security reform proposed by the government?

The Social Security reform is a proposed constitutional amendment (PEC 287) that would unify and streamline the rules governing the Social Security benefits granted to men and women, private-sector workers and public-sector workers, residing in urban and rural areas.

The proposal establishes that a person must be at least 65 years old and must have contributed to the Social Security system for at least 25 years in order to retire and receive Social Security benefits, regardless of gender, domicile or type of work. Under current rules, it is permissible to retire and become eligible for benefitsbased on either contribution time (35 years for men, 30 years for women) or age (65 for men, 60 for women), but some special regimes shorten the required period of work before retirement, as is the case for agricultural workers. Under the new proposal, men currently aged 50 and above and women aged 45 and above would be covered by transitional rules: they would have to work the remaining time for retirement under current rules plus an additional 50% of this time. The value of the benefits to be paid would start at 51% of the person’s average contribution, addedby 1 percentagepoint for each year of contribution, up to the limit of 100%, respecting the minimum wage floor and the Social Security ceiling.

For survivor benefits, the proposal would establish a base value of 50% of the earnings of the retired public-sector worker, plus an additional 10 percentage points for each dependent. No additional Social Security benefitswill be allowed.

For assistance benefits under LOAS/BPC, the minimum age for eligibility will be raised to 70 from 65 over the course of 10 years. A separate proposal would be sent to Congress defining the new rules regarding the value of the assistance benefits and the financial requirements for gaining access to them.

Finally, the reform proposes measures to address rural Social Security revenues , eliminating tax benefits for agricultural exports, and regulating contributions for rural Social Security.

2. Why is the reform needed?

In our view, Social Security reform is necessary because of the aging of the Brazilian population, especially in a regime with generous rules, such as a low retirement age. Hence, spending levels, which are already high given the country’s demographic profile, will increase steadily over time in the absence of reforms.

The aging of the Brazilian population will be rapid. The ratio of the number of people aged 15-64 to the number of people aged 65 and over will drop from 9:1 today to 4:1 in 20 years and 2:1 in 40 years, bringing an end to Brazil’s “demographic bonus”. Two factors are behind this trend: a decline in the birth rate (from 32% in 1980 to 14% in 2016, projected to reach 10% in 2040) and a significant increase in life expectancy (from 63 in 1980 to 76 in 2016, projected to reach 80 in 2040). These ratios are important for a Social Security system based on a pay-as-you-go system, in which contributions from the current generation of young people finance the benefits paid to the contemporaneous generation of elderly people.

According to our estimates, without reforms, Social Security expenses will rise at an average rate of 0.30% of GDP per year. Social Security expenses as a share of GDP depend on the growth rate of the number of beneficiaries and the growth rate of their respective benefits. To put it simply: Δ (Social Security/GDP) = Δ beneficiaries + Δ benefit value – inflation – real GDP growth. Because most benefits are tied to the minimum wage, and the minimum wage is adjusted every year in accordance with economic growth and the inflation rate, the last three terms in the equation cancel each other out and the spending dynamics are solely determined by the growth rate of beneficiaries. As Social Security expenses will be close to 10% of GDP in 2020 and the number of beneficiaries will rise by 3.0% per year between 2020 and 2030, Social Security expenses will increase, on average, by 0.30% of GDP over the same period.

Importantly, if benefits as well as the minimum wage were decoupled from adjustments in real terms, there would be a relief from this trend equal to real GDP growth (in the simplified equation above, benefits and inflation would cancel each other out and we would be left with real GDP growth).

The objective of the current proposal is to adjust the growth rate in the number of beneficiaries to Brazil’s new demographic reality. The proposal would also adjust the value of some benefits by decoupling survivor benefits and assistance benefits under LOAS/BPC from the minimum wage. However, retirement benefits would remain tied to the minimum wage. If there are no changes to the rules mandating yearly adjustments to the minimum wage in real terms, the productivity gains made by the current generation of young workers will continue to be transferred toretirees. This situation is not sustainable in the long run.

3. What are the main distortions in Brazil’s Social Security regime?

The most important distortions in the Brazilian Social Security system are a low retirement age, the different sets of rules and special regimes that govern benefit eligibility, and the coexistence of contributive and non-contributive benefits. The reform seeks to correct these distortions by establishing unified rules and a minimum retirement age of 65, regulating rural Social Security contributions, and changing the eligibility rules for survivor benefits and LOAS/BPC (assistance) benefits.

4. Is rural Social Security the only source of the system’s imbalances?

No. The unfavorable demographic trends will also affect urban Social Security spending and deficits (0.8% of GDP in 2016) year after year. Given a projected rural Social Security deficit of 1.7% of GDP in 2016, as well as the rising living standards in rural areas and the high level of judicialization in the granting of rural Social Security benefits, adopting measures to rebalance rural Social Security — in terms of both revenues and expenses — under the principle of unifying rules would be, in our view, a step in the right direction.

5. Compared with other nations, is a retirement age of 65 reasonable?

Yes. Brazil has one of the lowest retirement ages in the world. According to an OECD analysis, out of 34 countries analyzed, only 7 had a minimum retirement age below 65, and none had a retirement age below 60. The average age of retirement in Brazil is 56.

6. Would raising the retirement age hit the poor the hardest?

No. The increase would more sharply affect workers with higher incomes, who typically reach minimum contribution thresholds for retirement sooner due to their high qualifications and job stability. Furthermore, their high average incomes increase the value of their Social Security benefits, significantly inflating Social Security expenses. Meanwhile, low-income workers enter the labor market earlier but are subject to greater job informality and usually retire when they reach age 65 (men) or age 60 (women), under current rules. In fact, the average benefit granted is larger for those who retire based on time of contribution than for those who retire based on age, as the latter tend to be closer to the Social Security minimum wage floor. Therefore, the establishment of a minimum age would counter early retirement based on time of contribution, which generates greater benefits on average and tends to be used by more affluent workers.

7. What is the importance of the transitional rules?

The transitional rules would determine the medium-term impact of the increase in the retirement age on Social Security spending. If the proposed transitional rules were adopted, for instance, the rate of growth in the number of Social Security beneficiaries would be expected to fall more sharply from 2027 onward, as by then most of the population would be fully subject to the new rules.

8. Why not carry out a reform only for new entrants?

A reform that instituted changes only for new entrants to Social Security would take about 30 years to have an impact. Given the rate of population aging and the fact that Social Security spending is already high, the consequent path of spending and public debt resulting from such a long transition would be unsustainable.

9. Would there be any exceptions to the new retirement rules?

Yes. The main exception would be the special regime for military personnel in the federal and state governments, which would have to be addressed in a separate proposal or by state legislative bodies. In addition to military personnel, the proposal would maintain special retirement benefits for workers exposed toharmful agents and for the disabled.

10. If it is approved, when would the Social Security reform start to affect fiscal results?

The impact would likely begin to be seen in 2018, mostly due to measures involving tax receipts related to rural Social Security, and would thereafter increase over time. The savings arising from a higher minimum retirement age would start to build up by 2020 and would likely peak between 2027 and 2034.

11. What is the potential impact of the proposed measures on the growth rate of the number of Social Security beneficiaries?

Without reform, the number of Social Security beneficiaries will grow at an average rate of 3.5% per year, in line with the rate of growth in the population aged 55 and over, as 55 is the current average retirement age. According to our estimates, if the proposed reform is adopted, the number of Social Security beneficiaries would grow by 1.5% a year, on average, between 2018 and 2030.

12. What would be the impact of the proposed measures on Social Security spending and deficits?

According to our estimates, the proposed reform would result in savings of approximately 1.4% of GDP in Social Security spending and 1.5% of GDP in the Social Security deficit by 2025, compared with the no-reform scenario. Social Security spending and the Social Security deficit would be around 8.9% and 3.1% of GDP, respectively, in 2025, compared with 8.2% and 2.5% in 2016 and 10.3% and 4.6% if no reform is carried out.

In addition to the reform, if the minimum wage only remains constant in real terms, spending and deficits will be around 7.8% and 2.0% of GDP, which is slightly below 2016 levels. A share of 66% of Social Security expenses is tied to this variable. The minimum wage has shown significant real increases in recent years. Hence, the rule transferredproductivity gains of young workers to the retired. This is not economically sustainable in the long run and could make it impossible to comply with the spending cap.

13. Would the proposed Social Security reform enable the spending cap to be met by 2025?

Yes, if retirement payments rise in line only with inflation in the future. In 2016, Social Security accounted for 40% of total primary spending. According to our estimates, without a reform, this share would grow to 65% in 2025. With the proposed reform, this share would be 55% if the rule of real gains for the minimum wage is maintained or 48% if retirement payments grow only in line with inflation.

Importantly, if Congress dilutes some of the reform measures, particularly the transitional rules for the minimum retirement age, the impact on Social Security expenses would be delayed, possibly preventing compliance with the spending cap. Doubts would arise about whether the spending cap would be respected over time, likely leading to higher real interest rates and slower economic growth, and potentially causing Brazil to return to an unsustainable path of public debt growth. 

14. Would the Social Security reform improve the finances of the Brazilian states?

Yes. The reform proposal addresses regional government’s employees. It would eliminate the special retirement regimes for civil servants (teachers, for instance), which drive up states’ expenses. In fact, spending on inactive workers is the main source of the imbalances in the primary spending of Brazilian states. Annual average growth in these expenses has soared in real terms, rising from 3% in 2000-09 to 20% in 2012-16. The aging of the population and the low retirement age are the main reasons for this imbalance, which is why they are addressed by the proposal. On the other hand, provisions to end equal adjustments for active and inactive workers, increase contribution rates for public servants and reform the Social Security regime for state military personnel are not included in the proposal and must be addressed by state legislative bodies.

15. What happens if Congress rejects the Social Security reform proposal?

Without the Social Security reform, the government will not be able to meet the spending cap over time and the public debt trajectory will become unsustainable. Without the prospect of debt stabilization in the medium term, economic growth would be slower and real interest rates would be higher. Eventually, adjustments would have to be made, either through a sharp pickup in inflation or through government initiatives that would have more deeply negative effects on the population – as in Greece, where fiscal imbalances have led to an cumulative contraction of 32% in the economy since 2008 and to the elimination of social rights. Furthermore, along with other compensatory measures, Brazil would likely have to increase the tax burden by at least 4 percentage points of GDP to finance the growing Social Security deficit, which would be a huge drag on the economy’s recovery.


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