Pensions the world would like to forget

PUBLISHED : Tuesday, 18 January, 1994, 12:00am
UPDATED : Tuesday, 18 January, 1994, 12:00am

FOLLOWING three decades of intermittent deliberations about the wisdom of introducing a comprehensive old-age security system in Hong Kong, and having had the unusual opportunity of applying lessons from other countries' experiences with various systems, the Government has finally come up with an Old-Age Pension Scheme (OPS).

It is, alas, a ''pay-as-you-go'' (PAYG) system, such as those now haunting many Western countries. It also represents a 180-degree turn on the Government's penultimate proposal, called a Community-wide Retirement Protection System (RPS). While Legco hasrejected RPS in favour of a Central Provident Fund (CPF) - something the Government has consistently and rightly criticised - OPS as it is now described represents a worse pension option for the working population, a looming financial headache for future Special Administrative Region governments, and a bad deal for the Hong Kong economy.

Only informal details have been divulged so far, but the principles seem to be as follows: OPS will provide universal coverage for all citizens 65 and over, both outside and inside the labour force. The uniform benefits will be fixed at 30 per cent of the median wage, regardless of individual need or past contributions.

The mandated contributions will be levied from both workers and employers, each paying three per cent of salary income. Benefits to retirees will be paid by the government from the contributions of the concurrent working population, with no requirement to maintain a reserve fund (hence the term pay-as-you-go). Once approved, OPS can therefore kick in at once.

It is the latter feature of OPS that makes it appear attractive: the elderly in Hong Kong will immediately be able to obtain pensions exceeding the old-age benefits to which only the neediest among them are today entitled, and can share to a greater extent in the economic prosperity of the territory.

But one should draw a distinction between the welfare and pension aspects of the programme. As a pension scheme, the proposal is faulty because it sacrifices the long-term interests of all Hong Kong workers for a largely short-term relief for the elderly.

Such relief, however modest, is guaranteed only for the first generation of recipients. Future generations will have to pay the mandated OPS taxes on wages throughout their working careers. Moreover, the average worker can expect to get a raw pension deal in the process.

Under a PAYG system, unlike a private or a fully-funded plan such as RPS or even CPF, the benefits to the elderly are tied not to their own previous contributions, but to the contributions of the younger age groups. But declining fertility rates and rising longevity in Hong Kong, as elsewhere, imply that the proportion of those who will be asked to support the elderly will be continuously falling over time.

BASED on official demographic statistics, the crucial support ratio - the number of people in the age group 20 to 64 available to support each pension-age 65 and over - fell from about nine in 1979 to seven in 1993 and is projected to fall to about 5.5 in 2011.

The inevitable outcome is a huge financial crunch somewhere down the line. For example, if benefits and contributions are pegged at the proposed levels, and if wages are assumed to grow by two per cent above inflation, then using the Government's own forecasts of population, inflation and earnings one can calculate that total payments will exceed total mandated contributions by $915 million this year, with the annual shortfall rising to $32 billion by 2011 - the latter would be much higher if pensions were to be raised to, say, 40 per cent of median wages; still a modest rate by Western standards.

In this case, the projected annual shortfalls would rise from $6.2 billion this year to $67.7 billion in 2011.

The Government has promised to kick in as yet undisclosed future subsidies, based on its present outlays on old-age income support programmes, but it would not be able to eliminate the financial burden on taxpayers even if it used uncommitted budget surpluses to cover the shortfalls.

The Government's income is derived from taxes. It is the average worker and taxpayer in Hong Kong who must ultimately foot the pension bill.

These conclusions are borne out by the experience of the PAYG systems in the West, where the ageing of the population, the tendency of the welfare states to legislate generous mandated retirement benefits for the elderly, and the slowdown in productivitygrowth during the 70s and early 90s have exposed these systems to the threat of future insolvency.

To avoid it, the affected governments will have to either lower benefits to retirees or increase taxes on the working population.

The trend in the US over the 50 years following the introduction of this PAYG system is an example. The combined social security tax rates imposed on employers and employees have increased dramatically from two per cent of salaries in 1937 to 15.3 per cent in 1992. And the benefits have already been trimmed back since 1984 by raising taxes on pensions and advancing the age of eligibility for benefits in the future.

Many agree that had the Western states been in a position to roll back the historical clock on their mandated social security schemes, they would have opted for fully funded systems in which private markets play a major role, as did Chile in the late 70swhen it abolished its PAYG system.

Unlike the proposed pension scheme, RPS and, in principle, even CPF are immune to demographic changes or unrealistic set benefits, because under these plans, workers' pensions are proportional to their own life-time contributions.

This principle of proportionality also applies under the traditional family responsibility system, in which old-age support for parents depends on their own productivity and that of their offspring, which also gives parents an added incentive to raise productive and caring children.

A critical problem with OPS, and PAYG systems in general, is that they mandate fixed pension benefits that are unrelated to what the worker or his children will actually contribute, and how productive they will be during their working careers.

Although Government officials have called OPS a contributory scheme, the mandated contributions by workers and employee are taxes, by any reasonable definition of the term.

They are neither voluntary, nor do they provide benefits commensurate with contributions made on behalf of individual workers, as would be the case if workers and employers were to enrol in a private plan or even a mandatory RPS.

Requiring employers to bear this tax levy does not produce direct returns to their employees, whose pension benefits are fixed by the government. Such taxes merely raise the cost of labour, and the cost of doing business. In a competitive labour market where supply and demand forces dictate wages and employment, future increases in employment will be weighed down by the tax levy on employers - they will not rise as much as they would without taxes - so eventually the real tax burden on workers will be influenced by the combined tax on both workers and employers.

Proponents of OPS tout its provision of immediate improvement in the welfare to elderly people, regardless of whether and how much they may be contributing to the system. But under a universal pension scheme, many of the beneficiaries will actually be people with incomes, even business tycoons and their spouses.

FURTHERMORE, if the objective is to provide immediate relief to the indigent elderly, this can be achieved by improving the welfare provisions of the means-tested old-age programmes without imposing a universal pension plan which would yield an unfair return to the average worker.

The debate about the desired social insurance scheme for Hong Kong should not be misconstrued, therefore, as a contest between big and small hearts. There is not much merit in a pension programme that mixes welfare and pension objectives to the detrimentof the latter and at the expense of productivity growth.

Fully-funded schemes based on sound economic principles, such as RPS, can yield substantially higher returns to workers than OPS for any level of mandated contributions.

The Government now hails OPS as ''fair and inexpensive'', as opposed to alternative plans. But RPS, unlike OPS, is inherently fair to all workers, and it can also be legislated as a modest one, requiring low mandated contributions from workers and employers, which would leave workers both the opportunity and the option to enrol in supplementary private pension schemes. The same goes for a CPF.

It need not be a plan requiring the kind of exorbitant contributions imposed on workers and employers in Singapore. The main deficiency of a CPF relative to a properly designed RPS is that CPF lacks the elements of competition and choice that are encouraged by RPS for the benefit of workers.

It has been said that those who do not learn from history are condemned to repeat it. In the debate over the desired comprehensive social insurance programme for Hong Kong, this is not a cliche.

The author is a visiting professor of economics at the Hong Kong University of Science and Technology, and leading professor of economics at the New York State University at Buffalo