Promoting Compliance in Social Security Pensions

1. Promoting Compliancein Social Security Pensions ISSA Conference for Directors of Social Security Organizations in English Speaking Africa 3-6 October 2006 Prof. Noriyasu Watanabe A Visiting Scholar to the ISSA, April 2006-March 2007 President, International Pension Research Institute, Japan Rissyo University, Japan

2. 1. The Importance of Compliance • Compliance is essentially important for Social Security Schemes, particularly for the Social Security Pension System in the ageing society in the 21st century. 2. The main objectives of mandatory Social Security pensions are to seek to counteract individual myopia and to provide Social Security protection on the universal basis. No Social Security pension, funded or pay-as-you-go, DB or DC, publicly or privately managed, regardless of how well it may be designed, will achieve its objectives if participants do not comply with the contribution conditions. 3. “Pension governance is more important than pension benefit design” (ILO, Social Security Pensions: Development & Reform (2000)). Without promoting compliance, it would be impossible to establish better pension governance, not only in underdeveloped countries, but also in advanced countries. • Contribution evasion would strongly threaten the legitimacy, the financial sustainability, and the adequacy of retirement benefits in any public pension system. The problem of compliance evasion warrants greater attentions, so it is very important to develop strategies for promoting compliance. Enforcement of compliance is necessary to re-build public trust in pension governance.

3. ２. Ignorance of the importance of compliance • Curiously enough, almost all public pension policy debates have been dominated by the public-private question, and the fundamental issues of pension governance, such as the collection of contributions have remained on the sideline. • Even tripartite social dialogue rarely touches on this very important compliance problems. 3. Only a few researches and investigations have been made into fundamental characteristics of the compliance evasion in the world. 4. Social Security systems can function effectively only with the the stronger support of participants. Social Security organizations should be amended to be more effective, fair and transparent to establish greater trust of them.

4. 3. Compliance is very important to under-developed countries • Compliance is very important particularly to under-developing countries, where the universal Social Security pension should be established as soon as possible. 2. Many African governments intend to establish a replacement rate of 40 – 50 % with employees’ contributions of 1.6-5.0% mainly through Provident Funds. There are trends for changing Provident Funds to defined benefit pay-as-you-go schemes, as was done by Tanzania. But there are also trends to defined contribution systems with private management. 3. In general, and with certain exceptions, the coverage and effectiveness of existing Social Security pensions in Africa are very weak. This is attributable to a number of factors, some political and economic, and others which reflect failures in governance at all levels, from the design of systems to their operations and managements. 4. With social and economic development, the size of the black market and the informal sector, and the number of self-employed persons in the labour force should decrease greatly.

5. 4. Principal Types of Evasion The following are the principal types of compliance evasion by employers, employees and Government/Social Security Agencies (Organizations): 1. Employers: a. under-reporting numbers of employees in order to decrease social security contributions b. under-reporting of earnings of workers c. misreporting employees as casual, part-time workers or contractors d. failing to remit employees’ contributions or delaying remitting contributions to government/social security organizations or pension funds e. Employers in the informal sector are particularly eager for non-compliance 2. Employees: a. under-reporting earnings by collusion with employers, for decreasing burdens of social security contributions b. claiming to be self-employed c. change their jobs from formal sector to the informal sector d. opting for early-retirement or seeking a disability pension

6. 5. Principal Types of Evasion (continued) 3. Government/ Social Security Agencies (Organizations): a. Unfair, ineffective and non-transparent design of public pensions b. Inefficient management of Agencies c. Poor ability of Agencies to collect contributions d. Many unfair activities for tolerating evasion e. Little authority and few resources to enforce compliance with laws f. Poor morale of staff in Agencies

7. 6. Effects of Evasion • Contribution evasion has obvious implications for individuals. • But it also has greater implications for the State, which may be pressured to supplement inadequate pension benefits from general revenue. 3. Contribution evasion would change dramatically the universal and compulsory pension system to a voluntary system.

8. 7.Effects of Evasion (continued) 1. Increasing inequities between employers 2. Increasing inequities between employees • Decreasing solvency of pension systems and insufficient retirement benefits to participants in DB plan: a. Resulting in lower replacement rate and/or higher contribution rate b. Resulting in transfers from general revenue DC plan: a. Providing inadequate benefits to employees b. Resulting in consequent recourse to the guaranteed minimum pension financed by general revenue 4. Resulting in increase in retirement age contrary to hopes of participants

9. 8. Main Reasons for Evasion 1. Economic/Labour situations: a. larger weight of shadow economy/informal sector Bulgaria 36%, Romania 33%, Poland 27% (% of GDP,2001) b. higher unemployment rate 1990 2000 Bulgaria 13.2 % 20.8 % Slovakia 0.6 20. 6 Poland 3.4 14.4 c. higher inflation 2. Responsibility of employers: a. unlawful eagerness to reduce labour costs b. poor ability for record-keeping and management 3. Responsibility of workers: a. Myopic behavior b. Seeking early retirement, disability pension benefits or jobs in informal sector c. Severe poverty and pressing responsibilities to family d. Pretending to be self-employed, in order to decrease the burden of contributions e. Poor compliance sensitivity of self-employed, including farmers and fishers US: 58.7% (no contribution amounts/estimated true liability in 1997) Chile: 4% (compliance rate of contribution by self-employed in 1998)

10. 9. Main Reasons for Evasion (continued) • Responsibility of the state/Social Security organizations: a. unfair and poor design of pension plan: ・weak links between contributions and benefits ・same contribution/benefit amount for richer/poorer insureds ・some vested conditions which tempt contribution evasion b. too high rates of contributions in weaker economy c. poor quality of governance: ・administrative complexity of compliance procedures 　 ・inefficiencies of pension management ・poor IT systems, including computerization and telecommunication networks ・ poor abilities of control, inspection and enforcement d. Moral risks of the minimum guaranteed pension benefits e. Poor collection system of contributions In many countries in Central and Eastern Europe, there were common characteristics in social security reforms to neglect the important function of collection systems.

11. 10. Collection Systems 1. Trend towards the centralization of collecting Social Security contributions with taxes by a tax agency. But there is no movement towards decentralization. An income tax collection agency has extensive important verifications, oversights and enforcement functions 2. Centralization a-1. Tax agency collects not only taxes but also contributions of all social security systems. a-2. Tax agency collects contributions of some social security systems. b. A Social Security agency collects contributions of all social security systems. 3. Decentralization a. Each Social Security agency collects contributions of its own system or some other systems. b. Pension funds collect their own contributions.

12. 11. Collection Systems (continued) 1. Centralization a. A tax agency collects not only taxes but also contributions of social security schemes. USA: SSA is charged with identifying those who are delinquent in paying contributions, but the IRS has responsibility for collecting taxes, auditing taxpayers and payment. UK : Responsibility for social security contribution collection was shifted to the Tax Agency (BIR) in 1998. Separate agencies have responsibility for inspection and enforcement. Sweden: Tax Agency collect contributions of individual account plan, which was introduced in the1999 Pension Reform. Albania, Argentina, Bulgaria, Canada, Croatia, Estonia, Hungary, Ireland, Italy, Latvia, Montenegro, New Zealand, Norway, Russia, Slovak Republic, Slovenia b. A Social Security agency collects all social security contributions. Austria, Belgium, Czech Republic, Georgia, Lithuania, Poland and many countries former Soviet Union Republic

13. 12. Collection Systems (continued) 1. Decentralization a-1. One Social Security agency collects contributions of several social security systems. Germany: Public Pension contributions are collected by the Public Health System (some 1,200 statutory sickness funds), which are even reimbursed by the pension system for the collection costs. The public pension institutions conduct on-site supervision to determine whether the contributions were correctly collected. a-2. Social Security agency and some institutions collect contributions of Public Pensions. France: Pension agencies and institutions providing complementary pensions collect public pension contributions. ( French workers have enjoyed the Universal Occupational Pension System in reality )

14. 13. Collection Systems (continued) 2. Decentralization a-3. Each Social Security System collect contributions of its own System (and some other system(s)). Japan: Each public pension plan, each public health Insurance Plan and Social Security Agency collect contributions of its own (and some other system(s)). Romania: Movement toward centralized collection administration is exceptionally piecemeal. b. Each pension fund collect its own contributions. ( individual account funded plans ) Australia: Fund managers of mandatory occupational schemes Chile, El Salvador, Hong Kong, Malaysia, Singapore, Peru

15. 14. Amendment Policies Need for greater administrative and operational efficiency: • To establish better governance with principles of social solidarity and income redistribution, existing Social Security agencies should be reformed to be more efficient, to have greater accountability and greater trust of participants by strengthening network structure for IT techniques and efficient management systems of successful private companies. • More close co-operation of government agencies, and better systems of inspection, audit, enforcement and monitoring should be introduced as soon as possible. Employers’ records should undergo the more severe scrutiny of cross checks and audits. • Good systems of penalties, regular publications of names of evasion employers and other sanctions should be introduced. 4. The burden of enforcing compliance can be reduced by relying on in-direct policies which require employers to prove their full compliance to gain government benefits (examples: an import or export license, a government tender, loans, subsidies, or to be listed on the stock market). 5. With better economic and social developments, the black market and Informal sector should decrease.

16. 15. Amendment Policies (continued) Management of pension Agency and modernisation of communication and education tools: • Associations of employers and labour unions should realize the importance of compliance. Employers and workers should be given opportunities to participate in the supervision of the management of pensions. 2. Public education, public meetings and mass-media should be utilized efficiently to teach importance of social security pensions and compliance to people. Participants should be given easier one point contact with agency for their obligations and entitlements. 3. Not only annual report of pensions but also the individual annual report and e-mail news to the insureds should be made regularly to make participants know correctly the long-term financial situation of the system and their vested rights.

17. 16. Amendment Policies (continued) Privatization: Predictability could be expected by privatization ? 1. It is very difficult to reconcile the motives of private organizations with the task of administering mandatory social security pensions. There are no clear indications that large-scale privatization would result in more effective systems. Efficiencies through competition may be counteracted by the loss of economies of scale or because of advertising costs of private organization. 2. There is an inherent contradiction between the objectives of a mandatory social security pension which seeks to counteract myopia and to provide social protection on the universal basis, and the motives and approach of a private sector organization, which seeks to maximize income and minimize expenditure. • It would be impossible to expect predictability from DC plans and mandatory savings plans. Predictability should be the essential and integral part of social protection. 4. Chile and Argentina have suffered greatly by the lower rate of coverage and higher rate of contribution evasion

18. 17. Amendment Policies (continued) Collection System: New movements toward centralization • There are greater new movements to the centralization of collection systems of social security contributions to a tax agency. It allows the Tax Agency to achieve greater economies of scale, to obtain information on liable employers from multiple sources within governments, and to ease the reporting burden associated with compliance. Of course, existing Tax System and Tax Agency should be fair, efficient and transparent with enjoying greater trusts of people. • But many different types of institutions collect contributions in the world, and their collective experience fails to demonstrate that one is inherently superior to others. The greater shift from an existing system to a new one always involves transitional costs. Except in unusual circumstances, government that cannot make one collection system work well will be unlikely to do better with a different on. • Centralization of all social security contributions by a Social Security Agency could be another efficient and practical option. • The real determinations of success in collections do not lie in particular administrative arrangements but in a country’s economic strength, efficient competencies and stronger political will of the government. The fact that Hungary introduced the Centralization by Tax agency and Poland did not, would be interesting to Africa.

19. 18. Amendment Policies (continued) Unification of Social Security Pensions • To establish better pension governance with fairness, efficiency and transparency, the design of Social Security pensions should be amended. • In many countries, the Social Security scheme is fragmented between different sections of the population or different risks with duplicated functions and inconsistencies. But it is inconsistent with social insurance principles, unfair for equal treatment and its duplicated functions lead to higher administrative costs and higher evasion rates. Recently German simplified Social Security pensions from five to two. 3. Income-related pensions should be unified to one. But a higher contribution rate should result in higher contribution evasion. It would be better for underdeveloped countries to establish a universal system as soon as possible with a lower contribution rate. 4. The occupational pension act to protect the vested rights of pension participants should be enacted as soon as possible for wealthier employers/industries to establish easily Occupational Pensions. 5. Anti-poverty social security pension should be financed not by contributions of participants but by general revenue. Design of the minimum guaranteed pension should be made carefully not to cause moral hazard of people.

20. 19. Amendment Policies (continued) Self-employed, informal sector and others: 1. Self-employed workers( including farmers) and workers in the informal sector are a problematic group not only in every social security system, but also in every tax system. To establish better systems to catch the correct incomes of self-employeds would help not only with contribution evasion but also tax evasion. Unfair treatment of insureds cannot decrease contribution Evasions in pensions. How to define the minimum contribution rate for self-employeds is one of the difficult problems. It is 60% of average wages in Poland, 25% in Romania, and the minimum wage in Hungary. • As the contribution rate or payroll tax is generally set as a flat rate, it represents a large percentage of wages of lower-wage workers. So it would be better for underdeveloped countries to levy lower contribution rates on workers of lower wages, as an efficient policy for reducing the size of the informal sector and contribution evasion. This policy could reduce temptations for employers to hire people as “off the books” particularly in the informal sector. The matching of tax contributions to lower wage workers by the governments could also same results. • When evasion rates are high, as a second choice it could be a good policy for the government to establish a special pension for self-employed (and lower wage workers in informal sector) with lower contribution rates. The rationale for such polity is that self-employeds usually are perceived that they are unduly burdened with both halves of the payroll tax. But many researches and much statistical evidence indicate that the employers’ share of the payroll tax is borne by employees in the form of lower wages. • For many people, health care is today’s problem but pensions are a future problem. A policy should be introduced that only insureds who have made full contributions to pensions could enjoy health care benefits.

21. 20. Conclusion • Without achieving greater administrative and operational efficiency of social security pension system, higher contribution evasion would result in severe distrust of social security systems which would break down welfare policies in the 21st century. 2. Reliance on borrowed models from other countries would be particularly ill-suited to the compliance field because successful collection systems always reflect correctly the fundamental elements of history, social- economical situations, different situations of social security systems including size and resources in each country. • After comparative research of compliance in the world, each government should find its best policy by itself which is most appropriate its own country from the point of better pension governance. • About 2,500 years ago, Buddah cleverly taught people as follows: Japanese words:「脚下照顧」 “To see your own feet” ＝ “To know yourself clearly for your excellent human life”