I stumbled upon this in my travels. Surprised me. It's quite detailed so I've posted only a bit of it.
Pension Reform in Sweden: Lessons for American Policymakers
by Goran Normann, Ph.D. and Daniel J. Mitchell, Ph.D.
Backgrounder #1381
Sweden has a long tradition of social insurance.1 Indeed, it was the first nation to implement a mandatory government retirement system for all citizens.2 Nevertheless, Sweden is now one of the world's leaders in the global shift to private pension systems.
The Swedish pension program faced financial problems similar to the troubles plaguing the U.S. Social Security system, and the Swedes decided that partial privatization was the best solution. For Americans, the Swedish example shows that pension reform and privatization are sound solutions to a pressing problem.
In Sweden, pension reform occurred because policymakers from both sides of the political spectrum realized that reform was the only way to ensure a safe and comfortable retirement income for today's workers. During the 1980s, Swedish lawmakers became increasingly aware that the country's National Basic Pension and National Supplementary Pension were not well adapted to meet future challenges. After reviewing the possible options for reform, including the recommendations of a committee appointed in 1992 to study the issue, Swedish policymakers decided that both individual workers and the overall economy would benefit if the old-age system were partially privatized.
The Swedish parliament, the Riksdag, reached an agreement to reform the system in 1994 and approved implementing legislation in 1998. The new system, which is fully effective for all workers born in 1954 or later, has four key features:
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Partial privatization. Workers must put 18.5 percent of their income aside for retirement, but they are now able to invest 2.5 percentage points of that amount in an individual account. Beginning later this year, workers will be able to choose the pension fund that best suits their investment preferences.
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Individual accounts. The remaining amount, 16 percentage points, is a tax that funds the pay-as-you-go government program. The Riksdag also altered this portion of the system dramatically. Instead of providing a pre-determined retirement benefit based on number of years in the workforce and earnings history, the new system provides benefits based on the amount of taxes paid during the worker's career. By creating a system of notional accounts (no money is actually deposited) and linking retirement benefits to lifetime income, the parliament has set the stage for further privatization.
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Safety net to protect the poor. As in other nations that have shifted to personal retirement accounts, a safety net will exist under the new Swedish pension system. The government will continue to guarantee a minimum pension funded by general tax revenues.
* Transition to protect retirees and older workers. Although the old pension system no longer exists, current retirees and older workers will continue to receive all or some of their retirement income based on the rules that existed before reform. Individuals born before 1938, for instance, will receive all the benefits promised by the old system. Retirement income for those born between 1938 and 1953 will come from a combination of the new and old systems.
Sweden's reformed pension system will yield substantial benefits for workers, retirees, and the Swedish economy. The key benefits include:
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Budgetary savings. Partial privatization, combined with reform of the government-run, pay-as-you-go portion of the retirement system, is expected to result in a fiscally sustainable system. Future expenditures will be significantly lower, protecting Swedes from higher taxes, higher spending, and large deficits.
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Higher retirement income. The ability to invest privately over a working lifetime will allow Swedish workers to benefit from compounding returns. The average blue-collar worker, for instance, should enjoy 40 percent more old-age income. Swedish retirees will have a safer and more comfortable retirement.
* Economic growth. By reducing the payroll tax rate and creating a direct link between lifetime income and pension benefits, Swedish pension reform will increase incentives to work. Moreover, the shift to a funded system will boost national savings, thus providing capital for future growth.
THE NEED FOR REFORM
All industrialized nations are confronted by the same challenge: Their tax-and-transfer pension programs face serious demographic and financial pressures. In effect, policymakers have only two choices. On the one hand, they can raise taxes and cut benefits in an effort to prolong the solvency of government-run old-age systems. Alternatively, they can give workers private retirement accounts. Faced with this choice, Sweden decided that reform was the best option.
Why did Sweden's lawmakers decide that they had to reform the Swedish old-age pension system? Among the key factors were:
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Long-term deficit. The unfunded pension system liability in 1996 was nearly $500 billion, roughly equal to 200 percent of Sweden's economic output.
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Demographics. In 1950, there were more than five working-age people for each person over age 65. Now there are fewer than four, and the ratio eventually will drop to three working-age people per retiree.3
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Future tax increases. Payroll tax rates already were high—nearly 20 percent—but they would have had to rise even more to keep the existing system in balance. According to Swedish government estimates, the tax rate would have needed to be as high as 36 percent by 2025.4
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Economic impact. The system's high tax rates discouraged output and employment. The adverse effect on work incentives was particularly severe because of a weak relationship between the taxes workers paid into the system and the benefits they expected to receive. In other words, workers had an incentive to work less and to underreport their income since increased pay simply meant higher taxes without an accompanying increase in future pension benefits.
* Fairness. Pension benefits for retirees often varied greatly. Because old-age benefits were based on a worker's 15 highest-earning years, two Swedes with equal lifetime incomes who had paid equal amounts of taxes could receive very different pension benefits. This formula discriminated in favor of higher-paid white-collar workers with peak-earning years at the expense of blue-collar workers with relatively stable earnings.
The Old System
heritage.org |
