Pension reform is a complicated and treacherous task — sometimes even fatal. Nicaragua, Brazil and Greece are good examples. It is associated with stakeholder ego, fiscal sustainability, economic performance, the state credit rating and, of course, election campaigns.
Soon after her inauguration, President Tsai Ing-wen (蔡英文) announced the establishment of the Presidential Office’s Pension Reform Committee on May 30, 2016. With courage and determination, she is to fulfill the Democratic Progressive Party’s (DPP) long-standing promise to overhaul Taiwan’s pension system.
Through regional forums and a national conference, the committee has taken a bottom-up, transparent and democratic approach to forge a consensus.
Based on recommendations by the committee, the Legislative Yuan passed a package of amendments to the existing pension system on July 27 last year.
The key change is that the annual 18 percent preferential interest rate on a portion of retired civil servants’ savings is to be gradually reduced to zero over 30 months, from 2021, for those who receive their payments in monthly installments.
Retired civil servants who have opted for a lump-sum payment are to see their preferential interest rate drop over six years to 6 percent.
The removal of the 18 percent preferential interest rate constitutes a remarkable achievement for the DPP government. It is estimated that the government would save NT$80 billion (US$2.67 billion) annually.
Currently, retirement payments account for NT$208 billion, or 1.2 percent, of GDP. This ratio is expected to be reduced substantially.
The new law also stipulates that the income replacement ratio is to gradually decrease over 10 years from 45 to 30 percent for those who have worked for at least 15 years and from 75 to 60 percent for those who have worked up to 35 years.
The new law stipulates that the retirement age for civil servants is to increase one year at a time, beginning from 60 in 2021 to reach 65 by 2026. The retirement age of teachers is to increase from 50 to 58 years by July 1 this year. It also guarantees that retired public servants and teachers are to have a pension floor of NT$33,140.
The retirement age should increase to 68 by 2026 because of low unemployment in Taiwan.
Following the global financial crisis in 2008, a lot of Western European countries encountered a rising unemployment problem, with an average unemployment rate of about 10 percent, so it was better for them to adopt a low retirement age, such as Greece and Italy where it is under 60.
However, Taiwan’s average unemployment rate for the past 10 years was only 4.4 percent, which is fairly close to the natural unemployment rate of 4 percent. This implies that Taiwan’s economy has almost reached full employment and that old workforces are not competing with the younger generation in the job market.
Taiwan has 3.3 million people in the 55 to 64 age group, and 3.1 million who are 65 and over. They are all baby boomers born after World War II, between 1945 and 1959. Extending the retirement age to 68 would avoid a shortage of labor by 2026.
Encouraging people to work longer is a sign of economic dynamism and evidence that Taiwanese live healthy, long and happy lives.
The average life expectancy in Taiwan is 76.8 years for men and 83.4 years for women. A retirement age of 68 would still give people plenty of time to enjoy their golden years.
Just because the government stipulates a retirement age of 68 does not mean that anyone has to keep working until they reach that age. They still can retire early if they like, so long as they have enough money to feed themselves without a government pension until they reach the stipulated age.
The military pension reform bill is in the Legislative Yuan for review and debate. Although veterans last month tried to storm the legislature to protest the bills, it is expected that amendments would be completed before July 1.
All parties have agreed in principle that military pensions should be generous, as they are in many other countries.
Major amendments in the military pension reform bill include a pension floor of NT$38,990 and that pensions are to be calculated based on a “55+2” formula.
This means that a person who has served 20 years in the military would be entitled to a full pension. The pension payment is equal to their average career salary multiplied by 55 percent. For every one year service, their entitlement would increase by 2 percent.
The main purpose of a pension system is to assist households or individuals in allocating their resources smoothly over time. This is achieved by transferring resources from working life to after retirement, when income dries up.
As Franco Modigliani, who was awarded the 1985 Alfred Nobel Memorial Prize in Economic Sciences said, a sound pension system must be a combination of redistribution and social insurance.
A pension system should ensure that all citizens, especially the old, have the resources to meet their basic needs. However, the primary reason for a nation to provide one is the belief that many citizens are myopic and do not accumulate adequate resources for retirement.
In short, pension systems are established to prevent nations from having to support a large segment of retirees.
Pension systems can also redistribute wealth from the well-to-do to the poor, who cannot afford to accumulate adequate reserves. Taiwan’s pension reform has fulfilled that objective.
As economic theory indicates, nations need savings for investment and individuals need savings to support themselves in the non-earning phase of their lives.
Using a variety of incentives such as tax credits and deferrals, and mandated contribution rules, the government should encourage citizens to increase their savings. The greater the need for such savings, the higher the contribution rate and benefit should be.
An example that can be learned from is Canada’s Registered Retirement Savings Plan (RRSP). The Canadian government allows, in addition to regular pension contributions, all taxpayers to deduct up to 20 percent of their gross earnings to deposit into an RRSP account in any commercial bank. People who choose to do this get tax credits when filing their income tax returns.
When taxpayers reach retirement age, they must withdraw their money from their RRSP account in a lump sum or in installments. To add this amount to their income they must pay income tax.
This is the best example of tax credits and deferrals and should be considered for future pension reforms in Taiwan.
Lee Po-chih is professor emeritus of economics and former vice president of National University of Kaohsiung.
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