Social Security in Chile

Demographics Chile

15,980,912 people 0-14 years: 25.2% 15-64 years:

66.7% 65 and up: 8% Population Growth

Rate: 0.97% Birth Rate: 2.02

USA 295,734,134

people 0-14 years: 20.6% 15-64 years: 67% 65 and up: 12.4% Population Growth

Rate: 0.92% Birth Rate: 2.08

Economic Performance Chile

GDP (PPP) $170 Billion

Real GDP growth: 6.06 %

GDP per Capita (PPP) $10,630.97

GDP per Capita growth: 4.85 %

United States GDP (PPP) $12.37

Trillion Real GDP growth:

3.5% GDP per Capita

(PPP) $41,800 GDP per Capita

growth: 3%

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Origins of Social Security Social Security is a system by which living

wages are paid to those who are retired. It is designed to enable the elderly and disabled to retire, but to still earn monthly incomes.

In 1898, Chile was one of the first American Nations to implement a Social Security program.

The United States did not adopt Social Security until 1935.

Origins of Social Security 1924: Government of Chile established a

national social insurance system for workers. A response to pressure exerted by the growing

number of worker organizations and strikes. Originally called “Caja,” the program was

modeled after system pioneered by Otto Von Bismarck in the German Empire.

Employee and Employer contributions to a state run fund.

Origins of Social Security 1952: Government of Chile

reorganized the The Workers' Security Fund. Created a Social Insurance Service.

This system lasted until after 1973, when Salvador Allende was overthrown in a military coup by Augosto Pinochet.

Social Security and the Military Coup

The new military government eliminated the traditional “pay-as-you-go” (PAYG) system. This system was similar to the system still

used by the United States, involving mandatory tax based contributions.

Laid the groundwork for the current privatized social security system, which involves mandatory contributions, with fixed exceptions.

“Pay-as-you-go” The government takes a percent of

workers’ monthly salaries and deposits it into a general social security fund. This fund directly finances social security

benefits paid to those currently retired: A PAYG type system relies entirely on

the willingness of younger generations to work.

How it Works The General Social Security Account, which is

not an investment in the economy, is merely a ‘holding place’ to keep the money until it is paid out in benefits. Any surplus that is in this general social security

account, the government lends to itself. However, there are no funds earmarked to repay this debt, meaning when it comes due, the government must incur new debt or raise taxes.

Various estimates from government actuaries predict the bankruptcy of the US Social Security system by 2030.

Fixing Social Security Although predicted bankruptcy is

not for another 25 years, the problem needs to be resolved.

Two main options arise to fix the solvency problem: Changing the tax structure. Privatization.

Four Types of Tax Systems Progressive tax systems are those in which,

as income rises, the tax percent increases. Regressive tax systems are those in which,

as income rises, the tax percent decreases. Fixed percent systems are characterized by

everyone paying the same percent, regardless of income.

Lump sum tax systems demand a required payment, regardless of income and percents: everyone pays the exact same amount.

Four Types of Tax Systems

Chile’s New System Chile’s private social security system was

implemented in 1981 due to non-solvency of the old system, in part from differential treatment amongst various retirees.

The new system privatized social security into publicly mandated but privately administered personal accounts. In the formal sector, 10% of workers’ monthly

earnings are deposited into their private account. There are a variety of private companies from

which to choose, who invest the monthly deposits.

How the New System Works Each worker deposits 10% of monthly

earnings, which the investment firms take and reinvest into stocks and bonds. This is similar to the idea of a mutual fund.

Preferential tax treatment: The money deposited each month is done so

without paying taxes on said earnings. Withdrawals are subject to government taxes.

Retirement age: Men: 65, Women: 60.

How it Works Money goes into the accounts and

is not-touchable until retirement. Upon withdrawal in retirement, funds

are subject to fees and taxes. New policy additions have created

voluntary savings accounts, with preferential tax-treatment, which can only be accessed a total of four times per year.

Workers in Transition During the transition process, the

government bore all of the costs, and paid out benefits from the general budget. Workers who contributed to the PAYG system,

received recognition bonds, which guaranteed 4% annual, inflation adjusted yields.

These bonds were put into private savings accounts. This process was expensive, reaching upwards

of 5% of total GDP in 1983.

Requirements The managing firms are required by law

to pay no less that 70% of the monthly salary earned by each client. If they have not earned sufficient revenue

on investments and cannot pay the allotted monthly amount, the firm must cover it out of their own reserves.

If the firm cannot cover the payments, the government, which insures the system, must step in to pay.

The Macroeconomic Model

Y = C + I + G + NX National Savings:

Y – C – G = I + NX Savings = (Y – T – C) + (T – G)

Savings = Private + Public In a PAYG system, social security contributions

appear in taxes and government spending, but do not factor into savings, since they are not saved.

In Chile’s privatized system, required deposits are are accounted for in private savings.

A New Model Create a model in which savings is a

function of time, reform, and GDP per Capita: S = f( time, reform, GDP per Capita)

Predictions: Given what we know about private

social security systems, this model ideally predicts a discontinuous best fit line, with the break in the year of initial reform.

A New Model

A New Model Best fit lines cannot be discontinuous.

Knowing this, the data based line should be more steeply upward sloping.

Specific data taken from regression results:

Y-int: -1.32 x 10^12 Slope: 4.48 x 10^8

A new model

Results of the New Model It is visible in the regression data

results that this model produces a very accurate prediction: It explains over 96% of the

relationship. There is a .05 % probability that the

relationship occurs by chance alone.

The Reality of Private Systems

Since the first generation to work and live under this private system are currently retiring, the actual effectiveness of the system is becoming visible. What has actually happened? Change in incentive structure: Moral Hazard.

Some informal sector workers contributed only enough money to be guaranteed the minimum retirement benefits, meaning the investment firms or government would have to cover the difference.

The Reality of Private Systems

There is a large dissatisfaction in Chile with the private system: Hidden withdrawal fees eat away final value of

savings. Some of these fees go to pay the costs of the investment

firms. In the USA, 99% of investment goes towards benefits and

1% towards overhead. In Chile, overhead is about 20 times as large.

There is a large underground economy in Chile. This, coupled with seasonal and self-employed workers, means roughly that only 60% of all workers are actually covered by the private system.

The Reality of Private Systems The private system is required to pay at

least $140 per month per worker. However, frequently the investment firms cannot meet these payments. Investment firms use up their reserves, and then

need the government to step in and bail them out.

The government of Chile is still spending large amounts of money to support the social safety net, which should ideally have been provided entirely from the private pension system.

This is to support the people who do not have large enough lifetime earnings to support their retirement.

Poverty Cohorts

Why? There are a variety of reasons why

the privatization of social security could be beneficial: Reduction in government spending. Reduction in government debt. Increase private savings. Increased standard of living during retirement. (Re-)Investment in the economy promotes

higher growth and many other things.Source: Poverty and Income Distribution in a High Growth Economy, 1987-98, World Bank.

Final Thoughts Both PAYG and private social

security systems have their perks and pitfalls, and the solvency of each is debatable. What will the future be of each type of

system? Which system would be easiest to

reform to more adequately support the retired population?