Four Measures for Social Security

Abstract

Notwithstanding the recent reforms, there is a consensus amongst international organizations that in Portugal both Social Security and the civil servants' pension scheme (the CGA) continue to be financially unsustainable over the long term. This paper focuses on Social Security (the private sector workers' scheme) and in addition to the sustainability issue it identifies other shortcomings of the system. Then, in the spirit of the current Framework Law for Social Security, we propose four measures that aim at correcting these weaknesses and that have been adopted as reform strategies in several OECD countries. We start by proposing a single benefit formula that is far simpler than the existing ones, that applies to all active beneficiaries, and that we estimate could halve the system's long-term financial unsustainability. In a way that does not worsen the budget, the second measure establishes strong financial incentives to postpone the age of retirement to after the age of 65. All active beneficiaries are eligible, including those that in the future will get a minimum pension. Their employers also benefit from these incentives. The third measure sets up a rule for annual pension increases that guarantees a moderate gain in real terms. Finally, to strengthen the adequacy of income in old age we recommend personal retirement accounts that, through regular premiums, guarantee the payment at the age of 65 of a reasonable public pension complement through capitalization. Aiming at democratizing the third pillar, we propose that the Government co-finance the savings of those with low income. Note, however, that this does not imply an increase in public spending given that this support is financed with the tax expenditure associated with the PPRs (the savings and retirement plans). These four complementary measures make up a reform package with a clear objective in mind: to improve the long-term financial sustainability of the fist pillar without increasing the risk of poverty in old age. The philosophy of the proposal is to give everyone both the opportunity and the necessary incentives to alter their behaviour in time to guarantee a pension in accordance with their expectations.