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Contents | Executive summary | How to obtain this publication | Additional info
The following OECD assessment and recommendations summarise chapter 2 of the Economic survey of Chile, published on 26 November 2007.
Contents
Macroeconomic management has been laudable and is building on previous achievements
The copper-price boom of the last three years has put the fiscal policy framework to the test. The structural budget surplus rule inaugurated in 2001 has called for maintenance of a surplus of 1% of GDP net of the effects on public finances of business and copper price cycles. Continued adherence to the fiscal rule – despite the change in government in 2006 – has allowed the authorities to avoid a pro cyclical stance in an environment of historically high copper prices, while delivering a reduction in public indebtedness (central bank and central government) and recently moving to a net creditor position. Buttressed by fiscal prudence, monetary policy continues to be conducted within a framework combining inflation targeting and a floating exchange rate regime. This policy setting has anchored inflation expectations within the target range of 2 to 4%. At end-2006, the Central Bank of Chile (BCCh) revised its 2001 guidelines on the operation of the inflation targeting regime, re emphasising the mid point of the 2 to 4% target range as its central target and lengthening its policy horizon to 2 years from 1 to 2 years. This is a sensible policy move for a central bank that had achieved inflation stability around its desired level. The Capital Market Law II was finally approved in March 2007, having been discussed in Congress for nearly four years. The law paves the way for further financial deepening, including through the development of risk capital. This macroeconomic policy setting is serving Chile extremely well and should therefore be maintained. An important challenge is to strengthen the provision of social services in ways that maintain a lean public sector in a low-tax, low-debt environment.
The reduction of the structural budget surplus target is consistent with macroeconomic stability and the improved public finances
The level of the structural budget surplus to be targeted by the government from 2008 was reduced from 1 to 0.5% of GDP in May 2007. The additional funds available as a result of the reduction in the target are set to finance additional spending on education. As discussed in the 2005 Survey, this policy move is understandable against a background of an improving net asset position and the need to satisfy multiple social demands in a country of Chile’s income level. On the basis of official estimates, the associated fiscal impulse is compatible with macroeconomic stability. As in the case of any spending increase, careful attention should be paid to the effectiveness of the outlays financed by the funds released as a result of the reduction in the budget surplus target.
Budget outturn, 1991-2007
Source: Ministry of Finance and OECD calculations.
The Fiscal Responsibility Law enacted in 2006 is further improving the policy framework
The Fiscal Responsibility Law, enacted in 2006, embeds the fiscal rule in law and introduces explicit formal mechanisms for using fiscal savings for funding future liabilities, capitalising the central bank and dealing with pension related contingencies. At the same time, the methodology for calculating the structural budget target has been adjusted to include revenue from molybdenum – a metal which Chile exports in large amounts and whose price has been volatile in international markets, thereby affecting public finances – and those accruing from the taxation of privately owned mining companies. These moves are consistent with the analysis presented in the 2005 Survey. While the Law is a sensible instrument for pre funding pension-related and other contingencies within the confines of the fiscal rule, there are options for strengthening it further. The fiscal savings accumulated in the Pensions Reserve Fund should continue to be invested abroad during the 10 year period in which withdrawals cannot be made as a means of further insulating the domestic economy from commodity price volatility. With regard to the recapitalisation of the central bank, whose net worth is estimated at -1.4% of GDP in 2008, benefiting from the favourable fiscal situation, the limit set by law (0.5% of GDP per year for 5 years) on transfers from the Treasury could be increased to allow for full recapitalisation at a swifter pace.
Much needed complementary pension reform is under way
A pension reform package, submitted to Congress in 2006, aims at addressing the main shortcomings of the current pension system: low coverage (given that only about 55% of the labour force currently contributes to a pension fund) and low density of contributions (because one half of those workers who do contribute do so for less than 60% of their working lives). Once approved by Congress, the new system will combine solidarity pensions for individuals whose retirement income falls below a certain threshold, possibly because of a patchy contribution history, with capped, top up payments to encourage workers who have accumulated enough capital to finance a pension above the minimum threshold to save more for retirement. Instead, the current system guarantees a minimum pension only for those workers who have contributed to a pension fund for a long enough period of time and does not provide any particular incentive for retirement saving. The proposed scheme therefore improves upon the current one, because it encourages savings through capped, top up payments while maintaining social protection for the poor. Once it is fully implemented, the cost of the reform is estimated at about 1% of GDP per year.
Individuals’ responses to the proposed incentives for retirement saving will be an important determinant of the success of the reform.
The strength of the incentives for saving introduced in the proposed pension scheme depends not only on the level of the solidarity pension, but also on the cap and marginal tax-equivalent rate on the top up payments. An increase in the value of the solidarity pension above that envisaged in the reform proposal (about one half of the minimum wage) would bolster social protection for the elderly, but it would also weaken the incentive embedded in the reform for low income workers to save for retirement, especially those who have never done so. Moreover, in the proposed system, the implicit withdrawal rate associated with the top up payment is equivalent to 37.5% tax on contributory pensions. A flat, uncapped, top up scheme would instead provide sharper incentives for saving but would also probably be prohibitively costly. At the same time, it should be recognised that it is not easy to offer generous incentives for saving for retirement at a time when other elements of social protection are being enhanced. This includes the introduction of unemployment insurance in 2002 – which is funded mostly by employers and employees and therefore entails a low fiscal cost – and the ongoing broadening of the array of publicly funded health care entitlements through the implementation of AUGE, a plan introduced in 2002 to ensure treatment for a number of pre selected pathologies for all individuals, regardless of whether they are insured privately or publicly. To compensate, the pension reform introduces fiscal incentives for formal labour force participation among youths and a government subsidy of 15% of the amount saved voluntarily for retirement for workers with formal jobs. Of course, gauging the appropriateness of the proposed incentives for saving for retirement is essentially an empirical question. But pitfalls could be avoided. The level of the solidarity pension should not be raised further in relation to the minimum wage, and effort should be made to raise awareness among the targeted population of the benefits of preparing for old age and, if needed, for enhancing the incentives for saving by recalibrating the value of the cap and the marginal tax rate on the top up payments, public finances permitting.
Contributions to a pension fund and health insurance are to become compulsory for own account workers
Making social security contributions compulsory for own account workers, who represent over one quarter of employment, is important, because currently only 5% of these workers contribute to a pension fund. The problem is that these workers may either not be able to afford to save for retirement or perceive it as too costly in relation to the benefit of old age protection, which creates incentives for non compliance. While efforts to bring “hard to tax” groups, such as independent workers, into the tax net are commendable, they are not free of enforcement costs, which will need to be carefully assessed. Therefore, enforcement should be stepped up further, and the perceived cost of social protection for independent workers should be assessed through regular surveys, which would allow the authorities to gauge the target population’s willingness and capacity to pay. Likewise, the reform proposal makes health insurance compulsory for independent workers 10 years after approval of the reform package. Because health insurance coverage is now already high for the population as a whole, including own account workers, health insurance could be made compulsory at the same time and following the same timeframe for implementation as in the case of pension contributions.
Options are being proposed for encouraging retirement saving by women and for enhancing competition among pension fund managers
The proposed pension reform package also bolsters incentives for workers whose attachment to the labour market is weakest, such as women and youths, to save for retirement. If approved, a year’s contribution based on earnings at the minimum wage level will be paid into a mother’s pension fund for every live birth, and life insurance premia will be reduced for women on account of their longer life expectancy. Measures to ensure gender equality are welcome but should not aim at overcorrecting an imbalance that currently exists by giving women a higher retirement income than those accruing to men with the same contribution history, accounting for life expectancy differentials. It would also be desirable to eliminate in a phased manner the gap that currently exists in the case of contributory pensions between the retirement age for men (65 years) and women (60 years), given that the solidarity pension is paid at age 65 for both males and females. This would also be consistent with pension reform trends in the OECD area. With regards to pension fund management, the reform proposal includes measures for fostering competition among fund managers, such as through a bidding process for new affiliates, with the aim of further reducing administrative costs. Also, the cap on the share of assets under management that can be invested abroad is to be raised from 45 to 80%. There appears to be considerable agreement between fund managers and the authorities on the merits of reform in this area. Greater flexibility in pension fund investment decisions could be permitted, including through the complete removal of the ceiling on asset holdings abroad. This would be consistent with greater reliance on prudential regulations for portfolio management issued by the industry regulator, rather than on mandated quantitative restrictions, as is currently the case.
The tax system is being improved to remove obstacles to financial deepening and to business sector development
The Chilean tax system is modern, and its administration is efficient. But payment of a stamp duty on credit and loan transactions, as well as on the issuance of fixed income securities, is inefficient. It is particularly onerous for small, family run businesses, whose access to credit is typically costlier than for their larger counterparts. In the past, the stamp duty discouraged competition in the banking sector, because loan renegotiations were liable for taxation, as in the case of new contracts. The authorities recognise these drawbacks. A gradual reduction in the statutory rate, which varies according to the maturity of contracts, is therefore planned through 2009. This initiative is welcome, and the time is ripe for making headway in this policy area. The authorities are right to implement it in a gradual manner, because revenue accruing from stamp duties accounted for about 0.6% of GDP in 2006 and because the revenue foregone and the benefits of reform in terms of efficiency gains are difficult to quantify. Additional recent measures to improve the efficiency of the tax system have focused on simplifying procedures and on creating incentives for innovative activities.
Composition of central government tax revenue, 1995‑2005
Source: SII.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English or in Spanish. It contains the OECD assessment and recommendations.The complete edition of the Economic survey of Chile 2007 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the Chile Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Luiz de Mello and Diego Moccero under the supervision of Peter Jarrett. Research assistance was provided by Anne Legendre.
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