Thursday, December 02, 2004

Retiring in Chile

I remember going to NYC and watching the nightly local news. I was amazed that there was absolutely no news from anywhere outside of NYC. It was as if the rest of the world didn't exist. Whereas my local news would broadcast the results of all MLB games that went on that day, in NYC you just got the Yankees and the Mets.

I think we are in a similar bubble when it comes to the US. How much news do we get about how other countries tackle problems and compare that with our ways? The two biggest issues we have to deal with in the US are health care and social security. When we are reforming social security, why don't we look at how other countries have tried to solve this problem and figure out what works and what doesn't? Pete Peterson wrote a great book Gray Dawn where he did such a comparison.

That is why I was glad to see this editorial in the NYT about Chile's social security system.

Chile's Social Security Reform Act of 1980 allowed current workers to opt out of the government-run pension system financed by a payroll tax and instead contribute to a personal retirement account. What determines those workers' retirement benefit is the amount of money accumulated in their personal account during their working years. 10 percent of their pretax wage is deposited monthly into a personal account. Workers may voluntarily contribute up to an additional 10 percent a month in pretax wages. The invested amounts grow tax-free, and the workers pay tax on this money only when they withdraw it for retirement.

Upon retiring, workers may choose from three payout options: purchase a family annuity from a life insurance company, indexed to inflation; leave their funds in the personal account and make monthly withdrawals, subject to limits based on life expectancy (if a worker dies, the remaining funds form a part of his estate); or any combination of the previous two. In all cases, if the money exceeds the amount needed to provide a monthly benefit equal to 70 percent of the workers' most recent wages, then the workers can withdraw the surplus as a lump sum.

A worker who has reached retirement age and has contributed for at least 20 years but whose accumulated fund is not enough to provide a "minimum pension," as defined by law, receives that amount from the government once funds in the personal account have been depleted. (Those without 20 years' contributions can apply for a welfare-type payment at a lower level.) Workers with enough savings in their accounts to buy a "sufficient" annuity (50 percent of their average salary, as long as it is 20 percent higher than the minimum pension) can stop contributing and begin withdrawing their money.

Since the system started on May 1, 1981, the average real return on the personal accounts has been 10 percent a year. The pension funds have now accumulated resources equivalent to 70 percent of gross domestic product, a pool of savings that has helped finance economic growth and spurred the development of liquid long-term domestic capital market.
Sounds pretty good. This is the direction I would like to see the US go. What were the costs that they had to deal with?
We used five "sources" to generate the extra cash flow needed for transition: a) one-time long-term government bonds at market rates of interest so the cost was shared with future generations; b) a temporary residual payroll tax; c) privatization of state-owned companies, which increased efficiency, prevented corruption and spread ownership; d) a budget surplus deliberately created before the reform (for many years afterward, we were able to use the need to "finance the transition" as a powerful argument to contain increases in government spending); e) increased tax revenues that resulted from the higher economic growth fueled by the personal retirement account system.
That is pretty expensive. It will be interesting to see how the Bushies deals with this. Obviously c) is not an option. Option a) is pretty difficult given how much Bush has already run up the debt and deficit, how foreigners own 40% of this debt and may not want to finance any more given the dollar is falling. b) will require raising taxes and I think this is the way to go, but politically I don't know if the Bushies will do it. d) is good, but cutting more is going to be tough while we are paying for 2 wars and increased homeland security. e) I'm not sure how much we are going to gain from this given that our growth is already good and is spurred on by consumers who will now be forced to save instead of spend.

via New York Times

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