Itaú BBA - Social Security reform: alternative transition rules

Macro Vision

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Social Security reform: alternative transition rules

abril 10, 2017

Keeping a short transition to the minimum age of 65 is crucial.

Please open the attached pdf to read the full report 

If approved as originally proposed by the government, the Social Security reform will have an impact in 2025 of 2.0 percentage point (pp) of GDP in higher revenues and lower expenditure per year, compared with the scenario in which no reform is approved. We estimate that the transition rule to a minimum retirement age of 65 is the proposal with the biggest fiscal impact (1.4% of GDP or 70% of the total impact). However, Arthur Maia (PPS-BA), the reform’s rapporteur in the Lower House, has signaled that the transition rule is one of several issues likely to be amended by Congress. In this report, we estimate the impact from alternative transition rules and assess the fiscal cost of any possible changes. Importantly, the more flexible is the transition, the greater the likelihood the government will be unable to comply with the spending cap by 2025, increasing the need to supplement the reform by either raising taxes or curbing expenditure elsewhere in order to achieve its fiscal rebalancing and ensure public debt trend become sustainable.

If approved as originally proposed by the government, Social Security reform will have an impact of at least 2.0 percentage point (pp) of GDP in 2025, compared with the scenario in which no reform is approved (see graph). On the spending side, the proposal [1] represents savings equivalent to 1.5 pp of GDP from INSS Social Security and BPC/LOAS welfare benefits [2]. These savings would come from changes to benefit access rules, adapting them to current fiscal and Brazilian demographics realities, and they do not take into account any changes to the current minimum wage rule. On the revenue side, there is a rise of 0.5 pp of GDP, mainly because people will continue working and making Social Security contributions for longer period of time. Depending on regulations to decouple BPC/LOAS from the minimum wage and on contributions made by rural beneficiaries, the impact on spending and revenues may even be 0.1% and 0.4% of GDP higher, respectively. However, these issues were not addressed in Constitutional Amendment Bill (PEC) 287/2016, therefore their impact has not been included in our calculations.

Of all the proposals, the transitional rule to a minimum retirement age of 65 will have the biggest fiscal impact through 2025 (see table). We note that increasing the minimum retirement age to 65 is a critical issue, but its impact is wholly dependent on the transition rule when analyzing fiscal impacts until 2025. Hypothetically, if the minimum age rose to 70 but only applied to new workers, there would be no impact over this period. Similarly, if the minimum retirement age is set at 60 but applied immediately, there would be a short-term fiscal impact. In terms of the overall impact representing 2.0 pp of GDP, we estimate that 1.4 pp of GDP (or 70%) will come from the transition rule, with 1.0 pp of GDP generated by lower spending and 0.4 pp of GDP by additional revenues.

However, the reform’s rapporteur in the Lower House, Arthur Maia (PPS-BA)[3], has signaled the transition rule is likely to change. Every transition rule is based on two parameters: eligibility and adjustment factor. Eligibility defines the number of people affected by the transition rule, and the adjustment factor defines how much longer these people will have to work, compared with current rules. According to the government’s proposals, men over 50 and women over 45 are eligible and will incur a 50% adjustment factor on the amount of time they would normally have to contribute before retiring under current rules.

The biggest criticism of the government’s proposed rule is that there is a disconnect between those on either side of the transition eligibility cutoff point. For example, considering that men retire at an average age of 56, based on the length of time they have contributed to Social Security, men aged 50 in 2018 will, on average, retire at age 59, while those aged 49 – and therefore not included under the transitional rule – will retire six years later, when they turn 65 (see graph). As a result, alternatives were put forward during debates on the reforms in an attempt to improve the way the transition is phased and/or increase the number of people covered by the transitional rule.

The problem is that the more flexible the transitional rule becomes, the less likely the fiscal adjustment is to succeed. Without a Social Security reform, the spending cap is unsustainable, increasing the likelihood of tax increases and significant cuts in other spending areas. In 2016, Social Security and BPC/LOAS represented 45% of primary federal spending, but without reforms this will rise to almost 70% in 2025. Equally, higher Social Security concessions will put tighter constraints on other areas of the federal budget, such as public investment, social benefits and payroll, if the government is to comply with spending cap rules. Taking this to its logical conclusion, the difficulty involved in carrying out the fiscal adjustment exclusively on the spending side makes tax hikes much likelier.

We are presenting four alternative transition rules to explain the fiscal costs of altering the government’s original proposals. Two of these alternative rules are based on amendments submitted by deputies on the PEC 287 Special Committee, and the others are hypothetical proposals we are using for simulation purposes. In addition to the fiscal impact in 2025, we will also present average annual growth in the number of Social Security beneficiaries in each case. The baseline scenario is what would occur if no reforms were approved, in other words, there would be zero impact on 2025 revenues and spending, while the number of beneficiaries would rise an average 3.5% per annum (see the summary table at the end of the text). The rise in the number of beneficiaries is a good yardstick, because it reveals how much the economy needs to grow to ensure that Social Security expenditure remains stable as a percentage of GDP, provided the minimum wage grows in line with inflation.

The first rule was presented in an amendment submitted by the deputy Paulo Pereira da Silva (SD-SP), which would have an impact equivalent to 0.3% of GDP in 2025, compatible with an annual 3.0% increase in the number of beneficiaries. According to the Special Committee Amendment No. 3[4] , only people new to the job market would be subject to a minimum age of 60 for men and 58 for women. All active workers would be included under the transitional rule, subject to a 30% adjustment factor (extra time) on the amount of time they would normally have to contribute before retiring under current rules. This proposal would have an impact of just 0.3% of GDP in 2025, which is 1.1% of GDP lower than the government’s original plan. This difference is close to the federal government’s total expenditure on education in 2016 (1.0% of GDP) and what it would raise if it reinstated CPMF (1.1% of GDP).

The second rule was submitted in an amendment from the deputy Pauderney Avelino (DEM-AM) and would have an impact equivalent to 1.0% of GDP in 2025, basing itself on an annual 2.3% increase in the number of beneficiaries. Under amendment No. 106[5] , the transition would combine a gradual increase in the minimum retirement age and a 50% adjustment factor on remaining contribution periods. Under this rule, only those who are 25 in 2018 would retire at the final minimum age of 65. Put more simply, the minimum age would initially be 58 for men and 54 for women, increasing by eight months for men and one year for women every three years. In addition to the age condition, people would still be subject to the 50% adjustment factor originally proposed by the government. The 0.4% of GDP difference in relation to the government rule is slightly less than spending on the Bolsa Família transfer program (0.5% of GDP) and close to the total that could be raised by reversing the entire “Simples Nacional” on Social Security revenues (0.4% of GDP).

The third rule uses a rising adjustment factor that would have an impact representing 1.4% of GDP and includes 2.0% growth in the number of beneficiaries.In order to eliminate the gap in the original proposal, the initial 50% adjustment factor would rise by 10 pp every three years, ramping up through the transition (see graph) to the minimum retirement age of 65. The 0.3% of GDP difference compared with the government rule is similar to the government’s primary expenditure on subsidies and grants and to the revenue the government forgoes by allowing people to deduct medical and educational costs from their personal income tax returns (IRPF).

The final rule establishes an increasing retirement age that would have an impact representing 1.4% of GDP, compatible with a 1.7% annual growth in the number of beneficiaries.This rule would only implement the minimum age requirement and would not include adjustment factors on people’s remaining contribution time. Initially, the minimum retirement age would be 60 for men and 56 for women. Every three years, retirement ages would be raised by a year. The rule provides a faster transition to the minimum retirement age of 65, and although it does have a more immediate impact, that impact would be similar to the government’s 2025 horizon. This alternative is important because it shows there is a way of changing the transitional rule without undermining its fiscal impact.

Ideally, we believe that whichever transitional rule is chosen, it should have an impact of at least 1.1% of GDP (or at least 80% of the transition under the proposed bill). Laxer rules would make it increasingly difficult for the government to adhere to the spending cap in the long term, and public debt growth would remain unsustainable. Economic growth would be weaker, and real interest rates would be higher. Without offsetting measures, the adjustment would trigger a swift increase in inflation or the adoption of some sort of alternative initiative that would have a significant and negative impact on the population, as in Greece. The country imbalance has resulted in a cumulative economic contraction of around 32% since 2008 and has dismantled social rights.


Pedro Schneider

[2] The BPC, included in the Social Welfare Framework Act (LOAS), guarantees one minimum salary per month for anyone over the age of 65 or who is disabled and whose per capita family income is less than ¼ of the minimum salary.


Please open the attached pdf to read the full report .

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