Thought du Jour

I have prepared notes on “Universality and the cost of basic pensions” for presentation at a meeting convened by HelpAge International, and thought that they might be of interest to at least some TdJ readers. These brief notes bring together my thoughts on means tests, and why I believe that they are almost always inferior to universal benefits.

A typical reaction to universal pensions is “That’s a great idea, but we can’t afford it, so prefer to give pensions only to those who need them”. This reaction appears to be common sense, but it is wrong. Means tests shift costs, but do not lower them because means tests are taxes on income or assets. They are paid by elderly citizens and, sometimes, their families. It is more efficient to fund basic pensions with general taxes paid by everyone. All taxes, with the exception of head taxes, distort choices. Of particular concern are taxes that discourage work and saving. Low taxes levied on an entire population are less distorting than high taxes levied on the elderly.

This is the efficiency argument for universality. It is valid even with costless and perfect targeting, with no stigma, no exclusion errors, no erosion of political support. It is a simple argument, yet often ignored because means tests are usually recorded as expenditure reductions rather than as tax collections. Framing is important. A message that means tests are taxes could appeal to voters across the political spectrum.

It is important to recognize that, even though universality is optimal, all means tests are not equally bad. Clear, simple rules are preferable to complex regulations that leave discretion to government bureaucrats. Rules matter more than whether the number disqualified by targeting is small (an ‘affluence test’) or large (a ‘means test’?). The term ‘affluence test’ is imprecise and adds nothing to our understanding of means tests.

…. continued here.

Thought du Jour has been monitoring an interesting development in Panama. The government that took office in July of 2009 launched a programme with the name “100 a los 70″, meaning one hundred (dollars) a month at the age of seventy. In Panama, one hundred dollars is a modest sum, equal to 25% of the country’s minimum wage, or 14% of its per capita GDP.

Approximately 160,000 of Panama’s three and a half million residents are aged 70 and older. According to official government sources (see below), 85,000 of them – more than half of those who would qualify by age alone – are receiving a one hundred dollar monthly pension. The number was previously somewhat higher, but “more than 7 thousand” beneficiaries were removed from the list.

From early yesterday morning, beneficiaries of the “100 a los 70″ programme went to various branches of the National Bank and the Savings Bank to receive payments corresponding to the last three months of the year – a total of three hundred dollars for the last quarter. Officials of the Ministry of Social Development say that payments will be made by December 17 to approximately 85,000 older adults. ….

The Ministry of Social Development (Mides) has purified the list by removing more than 7,000 older adults from the program.

Jessica Perez, program director, explained that this purification was accomplished by crossing the list of beneficiaries with records of different entities such as the Land Registry, the National Lottery and the Department of Motor Vehicles.

“100 a los 70 y su último pago del 2011“, La Estrella, 10 December 2011. (Spanish original, translated by Larry Willmore.]

Now, why would a person aged 70 years or older be denied a pension. According to written rules, posted on the internet, an applicant for the “100 a los 70″ benefit has to satisfy “only the following requirements or conditions”:

1. At least 70 years of age
2. No access to other pension or retirement income
3. Panamanian nationality
4. Residence in Panama

Mides (Ministerio de Desarrollo Social), “Programas:  100 a los 70“.  (Spanish original, translated by Larry Willmore)

This is very clear. The Panamanian pension is a universal minimum pension. There is no wealth test, and the only income test is one of retirement income. Presumably the beneficiary can continue to work and still receive an age pension.

But why, then, would the Ministry want to look into a beneficiary’s holdings of land, lottery tickets or motor vehicles? What possible relevance could these assets have?

Further down, in explanations published at the link above, the plot thickens.

Must the beneficiary reciprocate in any way?

Yes older people must have health checkups and must participate in discussions, lectures, courses, seminars and medical counselling. To receive a pension, the beneficiary should request certification of each health checkup and of participation in informative activities and show this certification to social promoters when they carry out their supervisory duties.

Ah! This seems, to me, to be an obstacle designed to stigmatise, to discourage the moderately affluent from asking for a pension.

There are more explanations. And the application process becomes more complex.

Can the benefit be suspended?

Yes will be suspended in the following cases:

Death of the beneficiary
Misuse of money
Change in eligibility status

What is considered misuse of the money from the program?

The program “100 at 70″ regards as misuse the spending of money on any activities that do not result in an improved quality of life. Examples are expenditures on gambling, alcohol, drugs and narcotics.

Ah! Panama requires recipients of its social pension to refrain from alcoholic drink, gambling other unhealthy activities. This is similar to the rules set up by Victorian poor laws in Britain and its colonies, which required beneficiaries to be of “good moral character” (Victorian code for ‘sober’).

I still could not understand why possession of land or an automobile should disqualify an otherwise sober and elderly Panamanian. My suspicion is that the government has wide discretion in deciding which applicants for an age pension should be rejected. My worst fears were confirmed when I read the following statement, published last year on the web page of the Government of Panama:

Social Development Minister Guillermo Ferrufino, in the Legislature, denounced that people of “high economic status” are taking advantage of the “100 at 70″ programme intended for older adults living in poverty.

“We had some situations of citizens high economic status joining the project and of others who are not making good use of the money,” Ferrufino said, referring to those who own farms, rental properties and other assets, so have no need for do not need support from the state.

He recalled that “100 at 70″ began with … 72,000 older adults; however, after more than a year of operation, the number of beneficiaries has increased to 88,000 people ….

He indicated that he anticipated “hiring of social promoters” to determine the exact conditions of those who need this state support.

“Now is the time … to put a final end to unscrupulous people who have inserted themselves into the project and do not need it,” the minister added.

Mides (Ministerio de Desarrollo Social), “Ministro presenta modificaciones a la Ley de 100 a los 70“, 13 October 2010. (Spanish original, translated by Larry Willmore)

This is not good. Vague and complex rules for eligibility can transform an otherwise useful social programme into a nest of corruption and clientelism. Stay tuned for more information. TdJ will continue to monitor developments. Hopefully opposition parties – or the press – will shed light on this.

Last March, I posted  a note on Thailand’s move toward universal pensions. Today I am posting an update, gleaned from a new paper written by two Bangkok-based researchers. A means-tested social pension in 1993 preceded Thailand’s ‘universal’ scheme. In the early years, fewer than 400,000 elderly persons qualified for pensions. In 2005 screening of applications was outsourced to local authorities and by 2006 more than a million elderly pensioners were receiving 500 baht (about US$15) each month. By March 2009, the last month of means-tests, pensioners on the list numbered 1.9 million.

In practice, there were many limitations to the implementation of a means-tested old-age allowance system. All local authorities had to follow the process that was made clear by the Ministry of Interior …. However, … the local authorities’ understanding of the process was extremely diversified. Some allocated the transfer to all elderly without applying any means-tested eligibility criteria while others followed the process strictly. …. More than 50 per cent of underprivileged elderly did not receive the old-age allowance ….

The implementation failure forced the Government to go from a means-tested to a universal scheme. …. The change in government ideology was also a critical factor in the transformation. It was reflected in the policy speech that Prime Minister Abhisit Vejajiva delivered … in April 2009, in which he showed concern that the old-age allowance be a right for the elderly and a reward representing gratitude from society

The 500 Baht Universal Pension Scheme officially started in April 2009 ….

All elderly (60 years of age and older) who are not in elderly public facilities or do not receive permanent income (i.e., recipients of a government pension, government-employed persons) are eligible for the Scheme. ….

Thailand is gradually moving from a targeting approach to universalism. For both health and elderly-income allowances, the country previously used a targeting approach because of fiscal constraints. However, there was concrete evidence that the poor were not protected properly and some non-poor received this benefit from both inclusion and exclusion errors.

An egalitarian approach to providing equal access to necessary health and social services was debated in the 1970s. Two decades later, after the economic crisis, social movements successfully managed to have the concept included in the 1997 Constitution, which led to a universal health-coverage policy in 2002. The efforts of other social movements and further advocacy by the organizations of the elderly pushed the idea of universal elderly income security into the 2007 Constitution. ….

Although mainstream social protection in Thailand is moving towards more egalitarian policies, the balance of social risk management between individuals and institutions is still a topic of hot debate, especially regarding the pension system. Many affluent groups advocate libertarian or laissez-faire views.

Thaworn Sakunphanit and Worawet Suwanrada, “The 500 Baht Universal Pension Scheme“, Sharing Innovative Experiences (Volume 18, UNDP, New York, 2011), pp. 401-415.

Thaworn Sakunphanit is Deputy Director of the Health Insurance System Research Office (HISRO). Worawet Suwanrada is Associate Professor (economics) in Chulalongkorn University.

The new scheme is almost a universal minimum pension, ‘almost’ because it excludes only government pensioners and only government employees. There is a pension test and a retirement test, but they apparently apply only to workers in the public sector.

There is much more in the full paper. One item (pp. 403-404) that caught my attention is a proposal to establish an “additional pension scheme for the working population in the informal sector” to supplement the 500 baht pension. The legislation, which is awaiting approval by Parliament, calls for creation of a voluntary, government-managed pension fund. Each member would contribute 100 baht (US$3)a month, with Government adding another 50 to 100 baht, “depending on the contributor’s age”. Contributions can be skipped without penalty. When contributors reach pensionable age (60 years), their balances will be transformed into life annuities and added to the 500 baht minimum pension.

This is an experiment worth watching. I suspect that no contributory scheme can attract participants who are very poor, but this one might attract significant numbers of those who are better-off. Government subsidies might, though, end up in hands of those who least need them. Another danger is the potential for government waste: administrative costs can be very high for such small accounts.

Update: The elderly (aged 60+) in Thailand are thought to number 7.24 million. 5% (361,000) are government employees or pensioners, so not eligible for a 500 baht pension. As of September 2010, 5.65 million were receiving a 500 baht pension, leaving approximately 1.23 million to be registered. Recall that when the scheme started in April of 2009, there were only 1.9 million pensioners, so the registration process has gone very well. Note also that the fiscal savings from exclusion of civil servants is not large. Total expenditure on the programme in fiscal year 2010 amounted to 0.37% of GDP.

Andrew Biggs, resident scholar at the American Enterprise Institute, explains in detail why proposals to means test Social Security (public pensions) and Medicare (healthcare for the elderly) are a bad idea. He suggests an alternative way to reduce benefits flowing to the wealthy.

The appeal of means-testing is easy to see. It would dramatically reduce entitlement spending, and in a way that could be justified as commonsense: Since we don’t have the money to give benefits to everyone, we should give benefits only to people who need them most. ….

But means-testing also has some serious drawbacks, especially when it comes to how the policy might shape Americans’ financial decisions. Means-testing entitlement benefits could punish the very people who work the hardest and save the most, depressing economic activity and discouraging good behavior. The cure for our fiscal problems could thus end up being worse than the disease. ….

There is an alternative approach — one that achieves many of the ends of traditional means-testing, but without inviting many of its drawbacks. The plan’s essential and distinguishing feature would involve limiting benefits based not on individuals’ incomes in retirement, but rather on their lifetime earnings. As noted above, Social Security already effectively does this, by paying proportionally lower benefits to people with higher average lifetime earnings. Today’s reformers could do the same, if to a greater degree.

For instance, the Social Security Administration already tabulates individuals’ average lifetime earnings as an intermediate step in calculating their retirement benefits. Reductions in Social Security or Medicare benefits, or increases in premiums, could be based upon this measure of average lifetime earnings rather than on income in retirement.

Unlike a strict means test, this approach would avoid creating powerful disincentives to save. Indeed, individuals facing lower Social Security benefits in retirement would have an incentive to save more during their working years to make up for the loss. ….

Incentives to work would still be undermined somewhat under such an approach. Reducing benefits based upon lifetime earnings would mean that, for each additional dollar an individual earns, the return through Social Security would be smaller. Thus, the “net tax rate” under Social Security — that is, the net value of taxes paid and benefits earned — would increase, and obviously higher tax rates discourage work.

But it is likely that these negative effects would be significantly smaller under a lifetime-earnings approach than under a traditional means test.

Andrew G. Biggs, “Means Testing and Its Limits“, National Affairs 9 (Fall 2011).

Universal benefits – without income or assets tests – provide the best incentives for citizens to work and save for old age. Andrew Biggs would agree, but claim that it is easier to levy implicit taxes (means tests) than explicit taxes, even when both fall disproportionately on the wealthiest citizens. I am not convinced.

The current issue of National Affairs also has articles by Bentley University economist Scott Sumner and by Chicago economist John H. Cochrane. Sumner’s essay, “Re-Targeting the Fed“, is a plea for the Fed to target nominal gross domestic product rather than inflation. Cochrane’s essay, “Inflation and Debt“, is a plea for fiscal austerity. “As a result of the federal government’s enormous debt and deficits”, Cochrane argues, “substantial inflation could break out in America in the next few years”.

Sumner’s proposal might be useful, since it would produce a somewhat more expansionary monetary policy. Fiscal austerity, though, is the last thing the United States needs when unemployment exceeds 9% and interest rates are very low. In my opinion, deflation is a greater risk than inflation in the US economy today.

HT Greg Mankiw, who agrees with me that there is no reason to worry about inflation at this moment.