by Lourdes Poma
The pension system and the social security whose bottom line is to provide retirement income security to ageing people are very important and they are becoming increasingly relevant due to world population ageing. The pyramidal shape structure of the population according to its ages, which was clear in the 1970s, is now disappearing. Although this fact comes as the result of many factors it is worth mentioning the following: a) a decrease in fertility rate that is the average number of children born to each woman, and b) an increase in life expectancy, which is a statistical measure of how long a person may live, based on the year of his/her birth and his/her current age.
According to the World Bank, the fertility rate in the world has decreased from 5 children in 1960 to 2.5 children in 2014; conversely, life expectancy has risen by 4 months each year since 1970. In 1960, the average person could only expect to live about 52 years, whereas in 2014, a person could expect to live nearly 71 years. In case of Peru, during the same period of analysis, the fertility rate has decreased from 7 to 2.5 children, and the life expectancy has increased from 48 to 78 years. Therefore, it is estimated that by 2050, the number of people in the world 65 and older will have doubled from 10% to 20%. This fact makes the promotion of retirement savings more relevant to alleviate poverty in elderly, as well as to reduce the financial pressure to new generations that must finance the good and services of elderly through taxes.
The problem of poverty in the elderly population is bigger in Peru. Although the Peruvian government has taken measures and policies to overcome this problem, especially during the 1990s when a lot of structural reforms were implemented, there is still problems to guarantee adequate pensions for all ageing people. According to the Association of Pension Fund Managers of Peru, by February 2015, there were almost 2 million people over 65 years old, 43% of whom do not receive any kind of pension; 27% receive a contributive pension from the Public Pension System; 23% receive a non-contributive pension, called “Pension 65”, which is a public program financed entirely with public funds, and, finally, only 7% receive a pension from the Private Pension System. Thus, the Peruvian pension system covers less than 50% of the population that is over 65 years old. Additionally, related to private pension system coverage, which is measure as the ratio of affiliates as compared to total economically active population (EAP), graph 1 shows that up to 2016, the Peruvian private pension system has one of the lowest coverage in comparison to others Latin American and Caribbean countries.
The low coverage of the Peruvian pension system is the result of many aspects, one of them might be the unequal treatment between own-account workers and employees. Currently, the contribution to any pension regime is mandatory only for employees. Own-account workers do not have to contribute to any regime of pension systems. Therefore, there is a lack of pension protection to this last group of workers. This fact will worsen the poverty level in the elderly population, while at the same time it will increase the budget needed by non-contributive programs such as “pension 65” that might generate fiscal deficits.
Graph 2 shows that own-account workers represent around 35.1 % of the EAP, and reveals that during 2004 and 2014, the percentage of unqualified own-account workers (i.e. non-professional or non-technical workers) has represented more than 95%. Consequently, it is imperative that government approve a policy to include all these workers in the pensions system, as well as take measures to incentivize the retirement saving of all contributors (workers).
Policy 1: Tax Shield
All contributions that workers make to their individual retirement account must be considered as a “Tax Shield”.
To analyze this policy of tax incentives/exemption for retirement savings, it is important to understand the multi-pillar pension system outlined by the World Bank, which was extended by a report made by (Holzmann, 2005). According to this model, there are five basic elements: The “zero pillar” that provides a minimal level of social protection (universal); the mandatory “first-pillar” or a contributory system linked to earnings that seeks to replace some portion of income, and it is publicly managed; the mandatory “second pillar” that involves individual savings accounts; the “third-pillar” that is voluntary, flexible and discretionary; the “fourth-pillar” that consists of “informal” intra-family or inter-generational sources of financial and non-financial support to the elderly. This tax shield policy should be applied only to the second pillar because our main goal is to increase the individual retirment saving levels of low-income people (people who does not have high incomes to cause extra or voluntary savings).
In addition, the tax shield policy must have a threshold. Evidences from other countries have showed that this kind of policy may become a regressive one. For instance, in the United States (US) -where tax subsidies for retirement savings have existed since the beginning of the permanent income tax system in 1913 (Georgetown University Law Center, 2010)-, there is a lot of discussion about the loss in federal tax revenues caused by these tax exemptions.
The US is reporting higher levels of fiscal deficits because the retirement savings have grown and the level of subsidies have become increasingly costly. In the appendix, it is included three graphs from (Friedman, 2015) that summarize the effect of the tax benefit in the US. For instance, Graph 3 shows a rapid growth of tax expenditures on pension contributions and it displays that in 2014 the tax expenditures for retirement savings totaled USD 146 billion, and according to the Office of Management and Budget projections this tax expense will grow at 7.6% annually over the next decade up to a total of $303 billion in 2024 (U.S. Government, 2015). However, the level of savings rates from 1970 and 2014 does not show a positive tendency (see Graph 5). And this became worse if it considered Graph 4 that shows that the distribution of tax expenditures is highly concentrated in the upper income class.
Therefore, to avoid consequences like in the US, our policy must include a threshold in the tax benefit and it should focus only on low-income workers.
Policy 2: Mandatory retirement savings
The tax shield policy must be complemented by a mandatory retirement saving policy for own-account workers.
Currently, only employees have to contribute to any of the two pension regimes in Peru (private or national). However, as in the previous section was mentioned, own-account worker participation is more than one third of the EAP (35.1%). Therefore, it is crucial to include to this group in the Peruvian pension system establishing an obligation to save/contribute.
According a recent study made by (Friedman, 2015) that includes a literature review about this topic, concludes “default savings rates” appear far more effective that tax subsidies, and that many savers are inattentive to tax policy when choosing the level of savings. In addition, based on the behavioral economy theory, most consumers have a present bias. Consumers prefer alternatives that have immediate benefits and future costs. Therefore, people avoid alternatives that imply immediate costs and benefits in the futures that is the case of retirement savings. Consequently, it is imperative to introduce mandatory savings.
A fact that supports this policy is what happened in the United States with the 401 (k) Plan, in which participation increased after introducing automatic enrollment, forcing employees to opt out if they did not want to participate. Therefore, from this perspective, for most of people, the lack of wealth at retirement may not be the consequence of well-formed preferences, but instead the result of procrastination or inertia (Skinner, 2007), so a government intervention is needed.
Policy 3: Guarantee a minimum pension
Extension of the guarantee of a minimum pension at the private pension system.
Complementary to the previous two policies, it is recommended to extend the guarantee of a minimum pension for all workers who contribute to some of the two regimens. Currently, only a portion of population have this benefit. Therefore, extend this guarantee, especially to low-income workers, can generate an incentive to save because they have the guarantee that they will get a minimum pension.
This policy will help workers to reduce the financial risk of having a defined contribution system, which is the case of private pension system, since the government commits to pay a minimum pension to eligible workers at the time of their retirement for life. The eligibility should depend of the number of contribution and the level of income.
To enact the proposed policies, the implementation process should involve the following aspects:
Coordination. – Since this reform involves public resources, a task group should be established. The task group is needed to coordinate the implementation of this policies. This task group will be composed by high-ranked officials and specialists in pensions, regulation and database collection from the SBS and the MEF. After the bill proposal is finished, it needs to be discussed and passed by the Congress.
Communication. This reform needs to be communicated clearly to all stakeholders. Therefore, the implementation should include periodical meetings with business journalists, civil society, graduate school professors in economics, and opinion leaders, to explain them the importance, cost and benefits of the reform.
Efficient use of resources. The resources applied to implementation of this reform must include existing processes and agencies avoiding disruption, competition, or conflict among the following entities: i) the SBS, ii) the MEF, iii) the National Superintendency of Tax Administration (SUNAT, for its Spanish acronym), iv) the National Labor Superintendency (SUNAFIL, for its Spanish acronym) that oversee the accomplish of the labor rights, v) the Office of Previsional Normalization (ONP, for its Spanish acronym) that manages funds of the public regimen, and finally, v) the Private Pension Fund Administrators (AFP, for its Spanish acronym).
Friedman, J. (2015). Tax Policy and Retirement Saving. presented in the Economics of Tax Policy.
Holzmann, R. (2005). Old-age income support in the 21st century: An international perspective on pension systems and reform. World Bank Publications.
Skinner, J. (2007). Are you sure you’re saving enough for retirement? National Bureau of Economic Research.
 According to the ILO) definition, employees are who get a basic remuneration not directly dependent the revenue of the employer – among whom countries may need and be able to distinguish “employees with stable contracts” (including “regular employees”); employers are who hold self-employment jobs (i.e. whose remuneration depends directly on the (expectation of) profits derived from the goods and services produced) and engage one or more person to work for them as ‘employees’, on a continuous basis; and own-account workers are who hold self-employment jobs and do not engage ‘employees’ on a continuous basis (According to the ILO).
 The Peruvian pension system involve two regimes: i) the private pension system where contributors have individual saving accounts, and ii) the national pension system that is based on PAYGO (Pay-As-You-Go) scheme administered by a state entity.
 In 2015 the federal deficit was $438 billion. In 2016, the federal government has estimated that the deficit will be around $616 billion.
 Employees are who get a basic remuneration not directly dependent the revenue of the employer – among whom countries may need and be able to distinguish “employees with stable contracts” (including “regular employees”).
 Superintendencia de Banca, Seguros y AFP (regulatory authority of Peru for banking, insurance and private pension sectors)
 Ministerio de Economia y Finanzas (Ministry of Economy and Finance).