Cross-country health care spending growth since 1990: how does the U.S. match up?

I have a new post at AEI's American blog today comparing health care cost increases in the U.S. to those in other countries since 1990. The conclusion: we're about average, and nations with more centralized health provision haven't been all that better at controlling costs over the last decade and a half than have we in the U.S. Here's the key chart:

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Argentina attempts to nationalize personal accounts system; workers object

Joaquin Cottani at the RGE Monitor reports on some interesting pension developments in Argentina that shed some light on Social Security policy in the U.S. Argentina, like most Latin American countries, bases its pension program on personal retirement accounts. Individuals contribute to their accounts during their working years, then at retirement use the account balance to purchase an annuity paying them a monthly benefit for life.

But the government of Argentina, led by President Cristina Kirchner, is attempting to end their personal accounts system. Is this a response to public pressure from Argentines who want the supposedly greater security and lower risk of a government-provided benefit? Not at all. In fact, it's a scheme by the Argentine government to paper over its current budget deficit and has parallels to what has gone on in the U.S. Social Security system for the past 25 years.

In the Argentine personal accounts system, workers pay contributions to their account fund, not to the government-run pay-as-you-go program. Argentina's government, however, is running a budget deficit and is setting their eyes on workers' account contributions. If workers are forced back into the pay-as-you-go system, the government gets access to their contributions which can be used to cover up deficits elsewhere in the government. Of course, the government is also obligated to pay these workers retirement benefits in the future – but these "implicit debts" aren't counted on the government's balance sheet , as they aren't counted on the U.S. balance sheet, and so the Argentine government effectively ignores them.

The Argentine government first tried to bribe workers back into the pay-as-you-go system by promising increased benefits later. This shows how eager the government is to get its hands on the workers' cash today. But few workers took the deal, and so now President Kirchner is apparently pushing legislation that would force Argentinean workers back into the pay-as-you-go program.

How does this relate to Social Security in the U.S., in particular the budgetary debate between the current pay-as-you-go system and proposed reforms using personal accounts? Since the last reforms in the mid-1980s, Social Security has been running payroll tax surpluses – collecting more in taxes than is needed to pay benefits. This surplus in Social Security helps cover up deficits in the rest of the budget. In fact, many analysts think that the Social Security surpluses encourage deficits in the rest of the budget. Moreover, when the rest of the budget borrows from Social Security, this borrowing isn't counted as part of the publicly-held national debt, the debt measure that most people focus on. In short, if we didn't have the Social Security surplus, both the budget deficit and the government debt would look a lot bigger than they do, and folks in Congress would be feeling more heat to do something about it. This is the situation that Argentina's President Kirchner is trying to restore.

Now, what happens if we allow people to invest part of their Social Security taxes in a personal account? Well, that immediately erases the Social Security surplus, which means that the budget deficit and the debt would start to look bigger. Now, some on the left blame this increased deficit/debt on the accounts, when in fact all the accounts do is reveal a budget shortfall that already existed. Moreover, to the degree that larger accounts create short term deficits, they also create assets that help pay Social Security benefits in the future. In other words, this claimed increase in the debt is mostly a function of government accounting, not of reality.

Update: Here's an editorial from the Wall Street Journal on the same topic.

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Progressivity versus generosity around the world

Looking around the world, some government pension plans pay high benefits (with high contribution rates). These plans tend not to be very progressive. Likewise, plans paying lower average benefits tend to be more progressive. I've put together a chart below based on data from the OECD, where the average replacement rate is on the vertical axis and the level of progressivity is on the horizontal axis. (Progressivity runs from 0, which implies a totally earnings related plan, to 100, which implies a flat dollar benefit for everyone, regardless of earnings.) You can see visually, and a quick regression confirms, that the two are highly correlated: about half the difference in the size of a program can explained by looking at the progressivity of the program.

The Netherlands, for instance, is both the most generous but the least progressive of the 19 OECD countries listed. The U.S. is around the middle of the pack: it's ranked 7^th in terms of progressivity and 13^th in terms of generosity. (If you invert the generosity scale, the U.S. is ranked 6^th, matching it up closely with its progressivity rank.)

I had played with this data a couple years ago, but thought of it again when I spotted a new paper entitled "Why are More Redistributive Social Security Systems Smaller? A Median Voter Approach," by Marko Koethenbuerger, Panu Poutvaara, and Paola Profeta. (The published paper is behind a firewall, but a working paper version is available here.) Here's a key paragraph:

Countries with earnings-related public pension programs have considerably higher contribution rates than those with flat-rate benefits. Disney (2004) reports that the effective contribution rates in the 10 OECD countries dominated by flat-rate systems varied between 14.7 percent in Australia and 23.7 percent in the United Kingdom in 1995. The range in the 12 OECD countries with more earnings-related benefits was between 22.4 percent in Germany and 57.7 percent in Greece. The average effective contribution rate was 19 percent in countries with flat-rate benefits, and 35 percent in countries with earnings-related benefits.

Here are their concluding remarks:

The relationship between the level to which benefits depend on past earnings and Social Security contribution rate has received little attention in the political economy literature, despite its robustness. In this paper, we suggest an explanation based on a standard trade-off between economic efficiency and redistribution. The efficiency cost of redistributing income is lower when benefits are earnings-related, encouraging voters who benefit from Social Security to support higher contribution rates. Low income voters weigh this effect against the reduced redistributiveness of more earnings-related systems. Our numerical analysis of several European countries suggests that the median voter model is able to explain the stylized fact that intragenerationally more redistributive social security systems are smaller.

The social security contribution rates predicted by the median voter model also have a strong correlation with the effective rates calculated by Disney (2004). This means that our median voter model is able at least in part to explain the levels of contribution rates and their cross-country differences. Even though our analysis focuses on steady-state political equilibria, our main result that benefit formula significantly affects political equilibrium contribution rates can be expected to hold also outside of steady-states. This suggests that the political response to population aging may crucially depend on to what extent benefits are linked to past contributions.

This last sentence is important, as Social Security proposals on both sides tend to make the system more progressive. Sen. Obama would increase taxes on high earners while implementing a tax credit to effectively lower payroll taxes for low earners. On the GOP side, most plans focus on reducing benefits for high earners, such as through "progressive price indexing." Social Security's progressivity hasn't changed a lot over the system's history, and it will be interesting to see how these proposals might alter political support for the program.

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Pension reform in Chile

The Associated Press reports that the Chilean government is preparing to roll out a significant reform of the country's pension program, which after its introduction in 1980 served as model for reform in Latin America and elsewhere in the world, and has been proposed as a reform model in the U.S. Given this, it makes sense to some of the issues involved with Chilean pension reform as they relate to the U.S.

The biggest problem with the personal accounts pension system in Chile, as with the traditional defined benefit program that preceded it, is incomplete coverage. In the U.S. coverage under Social Security is practically universal (less than 5% of workers aren't covered), and the vast majority of those not covered under Social Security take part in another pension program. In Chile, by contrast, the self-employed, who have never been mandated to take part in their pension program, make up almost 40% of the workforce.

For that reason, even though average replacement rates for full-time workers under the Chilean pension plan are quite high -- around 85% percent, versus around 45% under U.S. Social Security -- a large number of self-employed workers would reach retirement with insufficient savings.

In response, the Chilean government has maintained a minimum pension benefit for individuals with 20 years of participation in the accounts system. The minimum benefit is equal to around 25% of the average wage. In U.S. terms, this would make for a minimum Social Security benefit of around $10,500. (Using the Gemini model, I estimated the benefits for 1941 birth cohort, individuals who would turn 67 in 2008. Among those who had claimed benefits, 67% had an initial benefit lower than $10,500. This gives some perspective on how relatively high the Chilean minimum is.)

Since the Chilean minimum pension is means-tested, lower-wage workers have very little incentive to participate in the personal accounts system once they have reached 20 years of coverage. The minimum pension is relatively generous so they would lose much or all of what they saved in their accounts. It is almost certain that the presence of the minimum pension -- designed to assist low-wage workers -- has aggravated the problem of low participation.

What are the lessons of this for U.S. Social Security reform? Probably quite few. No existing reform plans allow workers to effectively opt-out of Social Security, as the Chilean system allows self-employed workers to do. As a result, even in personal account plans that contain a guarantee of current law scheduled benefits, this type of moral hazard problem would not express itself. (There may be other moral hazard problems with such plans, such as the incentive to invest in risky assets, but that is a separate issue.)

For a good summary of the Chilean system and its strengths and problems, see this paper from Mauricio Soto of the Center for Retirement Research at Boston College. Read more!