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Incentives under the New Pension Solidarity Pillar in Chile

Incentives under the New Pension Solidarity Pillar in Chile. Eduardo Fajnzylber Escuela de Gobierno, Universidad Adolfo Ibáñez Prepared for the XIV Meetings of the LACEA/ IADB/ WB/ UNDP Research Network on Inequality and Poverty (NIP), April 9, 2010, Tulane University, New Orleans.

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Incentives under the New Pension Solidarity Pillar in Chile

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  1. Incentives under the New Pension Solidarity Pillar in Chile Eduardo Fajnzylber Escuela de Gobierno, Universidad Adolfo Ibáñez Prepared for the XIV Meetings of the LACEA/ IADB/ WB/ UNDP Research Network on Inequality and Poverty (NIP), April 9, 2010, Tulane University, New Orleans

  2. Sección anterior: Etapa de ACUMULACION

  3. Contributory Social Protection • Traditional (contributory) pension schemes are often challenged in developing countries, due to weak formal labor market attachment • Average contribution density (Forteza et al,’09): • Chile (51%), Argentina (55%), Uruguay (58%) • Inevitably, the State is called to intervene, to prevent poverty in old age, through non- contributory benefits (first pillar)

  4. Poverty Prevention Pillar design PROTECTION INCENTIVES COST

  5. Incentives in practice … • Little is known (empirically) about the effect of long term incentives on formal labor market attachment: • Higher protection could reduce incentives to work formally (Income effect) • Means-testing could induce an additional disincentive, by “taxing” wealth accumulation (Substitution effect) • Idea: Prepare the impact evaluation of the New Solidarity Pillar

  6. This presentation • Presents the 2008 pension reform, with emphasis on the introduction of the New Solidarity Pillar • Describe the context in which the reform was passed • Show some preliminary results/projections • Discusses theoretical incentive effects • Advances potential identification strategies

  7. The 2008 pension reform • Main elements of 2008 reform: • Coverage: • New Solidarity Pillar + Bonus per child • Compulsory contributions from formal self-employed • Competition between Pension Fund Administrators (AFPs): • Bidding mechanism • Separation of Death and Disability Insurance • Investment regime: • More flexible regulation, higher foreign limit

  8. The New Solidarity Pillar • Non contributory benefits for • Old age (>65) • Disability (18-64) • “Integrated” with contributory benefits • Amount of the subsidy: • US$150 for people without coverage (PBS) • Complement (smaller) to individuals with pensions below US$500 (old age) (APS) • Eligibility: • Pension below US$500 (old age) • Age over 65 or disability status • Part of the 60% poorest of the population • Residency requirement

  9. Benefit schedules

  10. Context for the reform • Pension reform • Pending challenge of Government coalition since return to democracy • Recent coverage projections: • Half the population would not finance a minimum pension AND would not have access to Minimum Pension Guarantee (MPG) • Fiscal space • Created by gradual reduction in transition cost

  11. Pension projections Pension below MP, without MPG Source: Berstein et al (2006)

  12. Pension related Fiscal expenditure Source: ECLAC (2006)

  13. Preliminary indicators and projections • Implementation has been running smoothly • High take up rate, especially women • Projected coverage: • Lower fraction of individuals with no pension (only those in 40% more “affluent”) • Higher importance of mixed financing • Fiscal cost: 1.2% of GDP by 2025 • Bachelet: Popularity 84% (post earthquake)

  14. Projected coverage Source: Berstein, S., Castañeda, P., Fajnzylber, E. y G. Reyes (2009)

  15. Projected Fiscal cost of NSP Source: calculations based on Arenas de Mesa et al (2008)

  16. Beneficiaries of the NPS

  17. Incentives: Before the reform • Assistance Pensions (Pasis) • Only the poorest • US$90 • Not covered or those who exhausted their funds  High implicit tax for low pension individuals • Minimum Pension Guarantee (MPG) • 20 years of contribution + Pension below Minimum pension Restricted eligibility group (restricted coverage) Incentives to reach the 20-year step, disincentives to leave it behind

  18. Marginal effect of US$1: Pasis v/s NPS

  19. Minimum Pension Guarantee

  20. Summary of analysis of incentives • Introduction of NPS raises expected wealth, relative to Pasis+MPG  expected income effect • Implicit tax of NPS is smaller than that of Pasis for individuals with low pensions • Substitution effect (means-testing) of NPS is similar than that of Pasis but in different part of the wealth distribution (3rd quintile, rather than 1st)

  21. Potential identification strategies • Treatment 1: Eligible for SPS v/s not elegible for any program. • Dif before-after for “new eligibles” • Dif-dif “new eligibles” v/s “never eligibles” • Dif-dif “new eligibles 3rd quintile” v/s “new eligibles 4th quintile” • Treatment 2: Eligibility for SPS v/s elegibility for PASIS. • Dif before-after for “ex eligibles for Pasis” • Treatment 3: Eligibility for SPS or PMG v/s eligibility for PMG. • Dif b/w workers just below 50 at reform and individuals just above 50 at the moment of reform

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