How Can We Do with the Social Security System?

A project proposed by the National Social Security Institute and the Ministry of Labour and Social Policy provided for the establishment of minimum thresholds of obligatory social security insurance payments with respect to labour contracts. The plan was to differentiate 54 groups labour relations established by law according to worker's position and economic sectors. Immediately after the announcement of this project, the Institute for Market Economics declared its scepticism and pointed out the negative effects of such an administrative measure on labour market. The expected results would be, as follows:

" A negative effect on employment in the formal sector. The impact will be greater when the elasticity of labour supply is greater, something probable in a labour market of sectors with low productivity.

" A negative effect on disposable income.

" An increase in unit labour costs. This development will affect the supply and demand of goods on markets and in this way it will have negative impact on the value-added.

" Negative effect on the economic dynamics of firms and work positions and, consequently, negative impact on the average labour productivity and income.

" Part of the formal employment will be liquidated (not only officially). This prediction relates to those workers whose income is close to the minimum wage.

" Practically, the project creates minimum wages for every single work position, a wage that enterprises have to pay or at least pay the social security insurance payments. In this way, the state creates entrance barriers limiting the entrance of firms to those that can afford to pay the associated additional costs. For example, a firm involved in commerce should pay social securities corresponding to a wage between BGN 140 and BGN 340. If the firm cannot afford to pay, it either enters the informal sector or quits.

" The expected positive effect by the administration is BGN 400-million additional revenue in the budget of the National Social Security Institute. If we use a simpleminded model and compare these BGN 400 millions to the expected government revenue in the budget for social securities (BGN 3468.7 million), it is obvious that, according to the calculations of the administration, the increase in the revenue resulting from the enforcement of minimum levels of social security insurance payments will be 11.5%. Thus if we add those 11.5% to the relative weight of the expenditures for social security insurance payments, the burden of social security insurance payments increases from 32% (social security insurance payments, payments for funds "Professional Qualifications and Employment," and health insurance payments) to 35.68% and the disposable income decreases from 59% to 55.3% of the average wage.

Later, the Ministry of Labour and Social Policy abandoned its intention to create minimum thresholds of social security contributions and focused on the idea to establish minimum wages in various economic sectors.

In response to our criticism of the project for minimum levels of social security insurance payments, the social minister Lidia Shuleva asked us how to solve the problem with the non-payment of social contributions by the informal sector of the economy. We would like to offer several possible solutions to the above-mentioned problem. These solutions focus on long run positive effects and a time horizon of 2010 or even 2030. The search for a partial and/or provisional solution will quite possibly turn out to be inefficient and expensive.

Long-run system risks of the existing pay-as-you-go model

1. The lack of any incentive for those who pay social security contributions to choose a level higher than the minimum wage. That is, those who pay more do not receive more benefits, while everybody is guaranteed a pension in a small range of possible outcomes. The conclusion is that the revenue of the National Social Security Institute will not grow because the people are not motivated to allocate a greater share of their present income for future consumption.

2. This model is based on the principle of "solidarity." However, solidarity can hardly exist when the number of those who give is smaller than the number of those who get. Usually, the principle of solidarity works when the majority in a society generates income and pay, while a smaller group of people in need receive some kind of assistance.

3. The National Social Security Institute generates an enormous deficit (about BGN 1 billion for 2002) covered by the government, a deficit that nobody expects to decrease in the following years.

4. According to the statistics of the recent years, the deficit of the National Social Security Institute increases, so there is an increasing need for budget financing. In 2002, the deficit of fund "Pensions" is expected to be about BGN 668 million (according to the Act on the Budget of Public Social Insurance). However, if we added to the above-mentioned sum the expected BGN 220.7 million subsidies from the central budget to fund "Pensions," we will receive a total deficit of BGN 889 million. If we track the increase in the deficit of fund "Pensions," we will find out that the deficit increases from BGN 140 million in 2000 to BGN 442 million in 2001, and further to BGN 889 million in 2002. Obviously, the present model of social security contributions generates an ever-increasing gap between revenues and expenditures that the government will eventually be not able to bridge. Such a development endangers the stability of the whole financial system. To make clear the character of the problem, we would like to point out that the deficit of the National Social Security Institute equals 1,5 times the expected government revenues for 2002 from the income tax (about BGN 557 million). A drastic increase in the deficit is quite possible in the following years. Given the currency board and the fragile financial stability, such a development would lead eventually to the collapse of the social security system.

5. Given the currency board, the only way the government can cover additional expenditures is through an increase in tax burden. The instruments of monetary policy cannot be used to decrease the real level of its expenditures through inflation. Thus, it is reasonable to expect constantly increasing subsidies for the National Social Security Institute via the budget and the taxes.

6. When we discuss possible systematic risks before the currency board in Bulgaria, it is logical to point out that the existing social security system is a major risk. The fate of Argentina reveals that it is necessary to reform quickly and thoroughly all inefficient institutions, such as, no doubt, the social security system in Bulgaria.

7. It is very important to choose the right moment to reform the system. It will be much harder to try to find a solution of the problem when the difficulties of the budget associated with the increasing deficits come up to the surface.

8. Given the expected increase in budget expenditures related to the reform of the army according to the standards of the NATO, the adherence to the requirements for preservation of the environment (according to the agreements with the EU and the directives), as well as the recently announced plan to build a Nuclear Power Plant in Belene, the ability of the budget to meet additional expenditures will be severely limited.

Preconditions and Principles for a Reform of the Social Security System

1. Social security contributions should be regarded as a kind of saving: people save when they are young and productive for the times they will be old and not able to work. Everything else is redistribution of income. The interpretations of the Constitutional Court of the issues – "there is no doubt that the right of social security is closely related to their obligatory character," "social securities are a system for mutual help and solidarity designed to defend the common interest by covering the material need of those members of the community who are in need with the raised funds from the other members" (see Decision 5 from 2000) – are faulty and should not be used as a base of a new system.

2. Social security contributions should not be interpreted as an obligatory way through which the prudent and reasonable pay for the mistakes of the shortsighted and imprudent. If somebody does not want to pay his/her social security contributions, in other words he or she does not think about his/her long run prospective, this behaviour is a personal problem, not a problem of the whole society.

3. The decrease of personal responsibility is a dangerous illusion created by the existing social security system. In other words, the more people expect that somebody else will make a decision for them, the greater increase of various moral hazards takes place. The risk originating from the moral hazard consists of a conscious decision not take care of one's own future (savings) because of the hope that, when one becomes a senior citizen, he/she can rely on the redistribution of others' money. This behaviour leads to a decrease in predictability, so the chances of everybody in society decrease, too. In order to avoid moral hazard, there must be long run limitations of the discretion of the legislation to expropriate income and property. Therefore, the size and the scope of tax revenue should not be altered haphazardly according to the whims of simple parliamentary majorities.

Impossible and incorrect analogies with other countries

Those who support greater administrative control over the system and for higher minimum social security contributions usually point out other countries, such as Germany, Great Britain, and Switzerland as examples confirming their claims. In addition to the conspicuous differences between these countries and Bulgaria, we would like to address at least three factors that undermine any attempt to refer the experience of these countries to that of Bulgaria:

1. Whatever the reasons, while young people leave Bulgaria, there is a constant flow of immigrants, most of them young and working. This development reveals that, apart of the stimulus and motivation created by the pension system, other irreversible economic processes are taking place. The day when Bulgaria will attract qualified and ambitious young people is, unfortunately, distant. If the number of working people increases constantly, the pay-as-you-go model is possible. If the number of working people decreases constantly, this model is doomed to fail.

2. The inflow of investment in these countries partly explains the above-mentioned development. The foreign investment inflow contributes to the creation of new opportunities and attracts people with high income (this characteristics allow the state to collect high social security contributions).

3. There is also another difference, namely the long run confidence in the government. Despite all possible reservations and doubts, Swiss citizens do expect that after 40 years their government will carry out its promises. In short, it will provide a pension. In Bulgaria, people's confidence that the Bulgarian government of 2042 will stick to the promise of the Bulgarian government of 2002 is almost zero. This attitude originates from the bad habit of every Bulgarian government to abrogate all decisions of its predecessors.

The Broad Vision of New Social Security System

1. The first pillar of the new social security system is the safety net that guarantees protection for a relatively small group of people, such as physically disabled people, who objectively cannot take care of themselves. It is financed by the Central Republican Budget, so the source of this kind of protection is the collected taxes from the citizenry. The safety net treats all citizens as equal. Safety net's money is spent on the principle of solidarity. It is a mechanism of redistribution, so the spending of public money should be carried out in a simple, inexpensive, and transparent manner; thus we suggest that the safety net should be financed by the budget.

2. The second pillar is obligatory social security insurance payments to individual accounts at private pension funds. Although it is analogous to the second pillar of the present pension system, the following facts reveal some differences:

" Since there will be no longer obligatory social security contributions based on the system pay-as -you-go, this pillar constitute the core of the new system.

" There should be no administrative restrictions on the freedom to choose a fund and on competition among the companies managing the funds; for example, there should be no restrictions with respect to the investment portfolio of the funds.

" The funds should not invest predominantly in government securities because this policy will transform them in quasi-budget funds.

This pillar is based on the classic saving system, but in this case it is obligatory .We suppose that obligatory minimum social security insurance payments of 8% will generate sufficient amount of money for a minimum pension.

3. The third pillar is voluntary complementary saving that does not differ from the other types of saving. Those who want to receive more than the guaranteed minimum pension by the second pillar are free to choose how to increase the savings for their old age.

These facts lead to the conclusion that the National Social Security Institute should be closed.

The payments to present pensioners and to those people who will have insufficient amount of money at new funds due to late start will generate a temporary deficit in the system. We suppose that this deficit may be covered through:

" A bridge loan financing the reform of the social security system: we expect that the World Bank would grant this loan. In addition, we suppose that the reform will contribute to the macroeconomic stability and, therefore, will improve the conditions for borrowing from private institutions.

" An increase in government revenues as a result of the positive effects of the new social security system on economic activities.

" A reduction of government expenditures, such as those for the maintenance of custom administration, that may be used to cover the deficit of the system.

The primary objective of social security system is to avert the risks generated by the current system. Some of the expected positive effects are, as follows:

" The decrease in tax burden will have a positive effect on labour market because of the following developments: (1) a decrease in the total labour expenses, (2) an increase in the employment in the formal sector, and (3) an increase in the disposable income.

" The expected spillover effect from labour market to the market for commodities and services, an effect that will contribute to the increase in the value-added.

" Accelerated economic activities and the increase in the size of the formal sector may lead to an increase in government revenue: it is quite possible that the budget will experience the positive influence of Laffer effect.

" An increase in savings and, consequently, investment; such a development will increase the dynamics and the liquidity of stock and bond markets.