Pension Reform will not Reduce Poverty

Pension Reform will not Reduce Poverty

Tackling poverty is the main challenge facing the Georgian economy. According to the Prime Minister of Georgia Mamuka Bakhtadze, overcoming poverty can be achieved through inclusive growth.

“We will soon implement reforms that will enable more inclusive growth. These reforms will allow us to alter the existing economic model and adapt it to the concept of inclusive growth. Our main objective will be to eliminate poverty as soon as possible,” the PM stated.

‘Inclusive growth’ has become one of the most frequently used foreign terms among the members of the Georgian government. The World Bank defines inclusive growth as economic development, which encompasses broad sections of society. The term is primarily employed within the context of tackling poverty.

Since inclusiveness has become the stated benchmark for economic reforms, it should not have escaped the government’s attention that one of its flagship economic reforms – pension reform – will contribute very little towards reducing poverty. This is quite clear for all to see.

As part of pension reform, the state will pay 2% of each employed citizen’s untaxed salary into the latter’s pension fund via the Pension Agency. This will amount to a total of ₾90 million in 2019, and the sum is set to increase each year. Thus, the 2019 state budget will simultaneously fund the pensions of existing pensioners to the tune of ₾2 billion, and provide an additional ₾90 million for the pension deposits for employed individuals who reach the pension age.

Georgia has limited state resources. The central government does not have an infinite amount of money to distribute among the population. If that was the case, then the problem of poverty would have been eliminated long ago.

 The main fault with the current pension system lies in the fact that the monthly sum of ₾200 is not enough to provide pensioners with a dignified existence. On the other hand, the higher-income section of the population is not in need of a universal pension, which effectively represents a tax break for them. A more purposeful distribution of the existing pension funds is therefore possible, and it would have a certain effect on reducing poverty.

The new pension system will have characteristically different results – the state will spend considerably more budgetary resources on the provision of pensions for relatively wealthy citizens than for those who are in acute need of financial assistance. The reform will therefore have no significant effect on tackling poverty among the elderly. On the contrary, this system will affirm the social imbalance.

Let us compare two population groups.

According to the Revenue Service, 1.2 million people were paying income tax in Georgia in 2017, of whom:

1. 230,000 had an annual income of less than ₾1,200, or less than ₾100 per month. These citizens, provided that they will receive a similar income in 2019, will only save ₾72 throughout the year, of which ₾48 will be paid by these individuals themselves and their employers, while ₾24 will be paid out of the state budget.

2. 80,000 had an annual income of ₾12,000-15,000, which amounts to at least ₾1,000 per month. They will save a tenfold annual amount of ₾720through the pension system, of which ₾480 will be paid by these individuals themselves and their employers, while ₾240 will be paid out of the state budget.

The contrast between medium-income employees and those earning the lowest income is striking, with the former group receiving ten times more in state contributions from the total saved amount than the latter. That is precisely how the sum of ₾90 million reserved for pension reform in the 2019 state budget will be distributed, with citizens earning average and above-average incomes receiving the largest share, and those receiving the lowest incomes receiving a small share.

Lawyers believe that in light of the aforementioned circumstances, pension reform represents a form of state discrimination based on income. This, in turn, violates the constitutional principle of equality. The non-governmental organization GDI has brought a case against this norm to the courts.

“The given case sees persons who live in essentially unequal circumstances being discriminated against on the grounds of their material conditions. The state is allocating budgetary funds through the state pension system to individuals living in unequal material conditions in a discriminatory manner. Persons living in difficult material circumstances receive lesser amounts through the aforementioned contributions than those who are relatively better-off materially,” GDI’s lawsuit states.

The new pension system represents one of the most significant social reforms in the history of independent Georgia. One of its prerequisites is the establishment of a new, long-term trust from the citizens towards the state. This is due to the fact that the system covers lengthy periods of time – in some cases, more than 40 years.

The main obstacle to the reform is the absence of long-term trust towards the state. People remember the financial crisis and hyperinflation of the 1990s, which took the Georgian economy to the edge of a precipice. Therefore, there is currently no transparent environment in Georgia for the kind of long-term investment needed for this kind of pension reform.

In the absence of a transparent environment, the funds transferred by the population into the pension fund constitute an expense. These are funds that will no longer be available to the taxpayer. The social background in Georgia is quite bleak, with 69% of the population living in either extreme or relative poverty according to the World Bank. This means that for a sizeable section of the low-income population, the burden of having to pay an additional 4% will worsen their social situation further.

At the same time, the employer’s tax burden will increase as well, thereby reducing their budget by 2-4% during the first year. This could slow down the pace of job creation, which, in turn, will also affect efforts to eliminate poverty.

Although the government insists that the pension contribution is not a tax, international practice tells us differently. According to the OECD, if a payment into the social security fund is mandatory, then it ought to be regarded as a tax. For example, in Denmark, a health insurance payment is mandatory for people within a certain income threshold, but is optional for others. The mandatory payment is regarded as a tax, while the optional payment is not. Similarly, the mandatory state pension contribution in the United Kingdom is seen as a tax, while the optional private pension scheme is not.

Georgian employers are obliged to contribute to the pension fund. Otherwise, they will be liable to pay an administrative fine.

Similarly, the Supreme Court of the United States confirmed that the duty to purchase insurance under the ‘Obamacare’ program constituted a tax.

Apart from reducing the employer’s budget and the amount of tax funds available to the state, the pension system also has a moral fault, as the government denies people the freedom of choice to spend their money as they wish. This approach removes the principle of ethical autonomy, as the state decides what is best for the people. In this case, the government has decided that it is good for us to have pension savings, and what is more, it forces us to adopt its own specific model for accumulating such savings.

Although the accumulated pension funds will be monitored rigorously, the state will not guarantee that citizens will be able to recover their money in full. The state will have no obligation to this end, which means that the pension fund will not be immune from domestic and global economic events, be it market crashes, high inflation or economic crises.

Political events often represent a higher risk for pension funds than market processes. For example, the Polish government virtually expropriated the money from its pension funds in February 2014. In order to avoid a potential economic crisis, the Polish government seized a sum of 153 billion zloty ($50.4 billion) in treasury bonds from 13 private pension funds, an amount equal to more than half of their investment portfolios. Beyond the legal arguments, the main reason cited by Donald Tusk’s government was to reduce the state debt. The budget deficit was instantly turned into a surplus, and the state debt was reduced. However, millions of Poles suffered from significant cuts to their pensions.

It is possible to avoid the repeat of such a scenario in Georgia – the current and future Georgian governments may approach the issue of the pension fund more responsibly than their Polish counterparts. Still, the reform will clearly bring more economic benefits to those with higher incomes, while people lower on the income ladder will be left at the mercy of their basic pension, which currently amounts to a mere H200 per month.


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