Pension reforms and employment

Abstract

The Chilean social security reform became effective in November 1980, replacing a traditional pay-as-you-go system with a unified system based on a minimum required contribution towards an individual account. The reform lowered the combined contribution rates towards old age and disability pension and tightened the link between contributions and benefits increasing individuals' valuation of contributions. This paper offers estimates of ‘money's worth’ ratios for ‘typical contributors’ before and after reform, indicating that the post-reform money's worth of each peso of contribution increased substantially for all groups, and particularly for women. Using aggregate data on employment and output from 1960 to 2002, estimates imply that a 10% reduction in the payroll tax led to a 2% increase in employment, and to a 0.7 point expansion in labour force participation.

Keywords:

• Pay-as-you-go
• unified system
• individual account
• labour force participation

Notes

¹In 1979, pension ages were raised to put the system in balance (see Wagner, 1983).

²Rates vary by fund.

³See Decree Law 3,501 (November 1980).

⁴The basic salary was defined as the sum of total taxable wages over the five years preceding retirement, divided by 60. Indexing was only applied to the last three years.

⁵The old system also offered a minimum pension guarantee.

⁶Rules varied according to the specific fund. The rules presented here applied to the SSS fund, which covered more than 60% of contributors in 1980.

⁷The pension was 50% of basic wage for the first 10 years and 1% of basic wage per year thereafter, up to a maximum of a 70% replacement rate. Thus, after 30 years, only higher wages would increase the pension, not any further accumulation of work history.

⁸Workers above 60 (if women) and above 65 (if men) are exempted from the obligation to make contributions towards pensions. However, the obligation to sign up with a health care insurer does not change with age. Active workers, retirees and beneficiaries for disability are required to buy a health insurance plan, which can be public or private. Contributions towards a health care programme are equivalent to 7% of the taxable wage for active workers, and 7% of the monthly pension for pensioners, an amount that is subtracted directly from the pension benefit.

⁹For a discussion on the economics of this fee, and in particular, the implicit cross-subsidies on the financing of the workers' compensation insurance, see Valdes & Navarro (1992).

¹⁰The choice of health care provider is highly influenced by income and health status (see Sapelli & Torche, 1998).

¹¹By 1997 there were already 250,000 pensioners under the new system. Of these, approximately one half had opted for annuities, and one half for programmed withdrawal.

¹²The surviving wife must have been married to the contributor for at least six months before his death and for at least three years if the wedding took place with a male pensioner.

¹³See for example, Musgrave (1959) and Summers (1989).

¹⁴This is not a comparison of pension benefits before and after reform. Readers interested in this issue should see James et al. (2003).