Can We Afford Old Age Social Security?

Before 1997, the last British Governor Chris Patten proposed to introduce a pay-as-you-go social pension scheme. The proposal was withdrawn amidst widespread opposition, including from economists who pointed out such a scheme was fiscally unsustainable and its redistributive provisions would have perverse work incentive effects. In its place the Mandatory Provident Scheme was introduced.

 

Advocates of universal social pensions and welfare support for the retired elderly in Hong Kong continue to demand our government put in place schemes similar to those in Europe and theUS. The ageing population, the spread of poverty among the elderly, and more importantly, the advent of election politics will all keep the issue of old age social security support active on the political agenda for a very long time.

 

In the recent contest for Chief Executive both Mr. Leung Chun-Ying and Mr. Henry Tang put forward proposals for old age social security support. The fact that both candidates made fairly specific proposals is powerful evidence of the political clout of the elderly vote.

 

In this article I estimate the long term cost of Mr. Leung’s and Mr. Tang’s proposals and compare them with the long term cost of the current CSSA and SSA payments for the elderly. I shall also compare their proposals with one advocated by my colleague Professor Chow Wing-Sun.

 

On Three Determining Factors

 

My calculations are based on a model using two of the three most important factors determining the long term viability of a social security scheme. The first factor is the age composition of the population moving forward. Fiscal sustainability of a social security scheme depends on the relative shares of working and retired people. As the population ages, the probability that the scheme becomes insolvent will increase. An increase in life expectancy across the population without a corresponding increase in the retirement age reduces the effective work force relative to the stock of retirees and would similarly make the scheme more prone to insolvency.

 

The second factor is the future productivity of the working population. A faster rate of increase in productivity could improve the solvency of the scheme holding other factors constant. This productivity depends on human capital investments in education and health. Healthier people contribute more productive time, are more energetic, and live longer. These features mean they have a more productive working life. Investments in education and health are complementary. A person who expects to have a longer and more productive life will have greater incentive to invest in education. Skills acquired can then be used over a longer working period. This increases the rate of return to education. The effect of an increase in productivity is analogous to an increase in the working population.

 

The third factor, which is not considered here, is that an old age social security scheme with redistributive elements that transfer resources from richer to poorer individuals through taxes and transfer payments will inevitably reduce the work incentives of individuals. Extensive transfers will dampen incentives for work effort and affect productivity, leading to a higher probability of insolvency. I do not take into account this factor in my calculations; therefore, the findings will overestimate future productivity or real GDP growth per working population.

 

Table 1 presents actual annual percentage growth rates of variables related to real GDP and population for different periods between 1961 and 2011. The first thing to notice is that population growth rates have been falling and will continue to do so. The Hong Kong Census and Statistics Department forecasts that the annual growth rate for 2011-2039 will be 0.8%. The United Nations forecasts an even lower annual growth rate for 2010-2100 of 0.4%. The elderly population will peak in the mid-21st century so although population growth will slow, the ageing factor will begin to ease off in the second half of the century.

 

Table 1: Population, Working Population, and Real GDP (Annual Percentage Growth)

	1961-2011	1961-1997	1997-2003	2003-2011	2011-2039	2010-2100
Real GDP per working population	4.1	4.7	0.9	4.0	4.0	4.0
Real GDP	6.4	7.5	1.6	5.0	4.2	4.0
Real GDP per capita	4.7	5.4	0.9	4.4	3.3	3.6
Total population	1.6	2.0	0.8	0.5	0.8	0.4
Working population	2.2	2.7	0.7	1.0	0.1	0.05

 

Note: Population forecast figures for 2011-39 are from the Hong Kong Census and Statistics Department. Those for 2010-2100 are from the United Nations.

 

Optimistic GDP Growth Forecast

 

A simple measure of productivity is the real GDP per working population. This grew at an annual rate of 4.0% in 2003-2011 when the economy was recovering from the Asian Financial Crisis. Despite the onset of the Global Financial Tsunami in 2008, unemployment has been quite low. It is therefore reasonable to assume that this is the economy’s potential productivity growth capability.

 

I shall assume theHong Kongeconomy will be able to achieve this rate of productivity growth into the future until not only 2039 but also 2100. It is interesting to note the annual growth rate of real GDP per working population for 1961-2011 was 4.1%. Our assumption of a 4.0% growth rate in the future maybe somewhat optimistic since the growth rate would normally be decreasing over time. Using the assumed growth rate allows us to calculate the implied real GDP and real GDP per capita growth rates for the two forecasted periods. The results can be found in Table 1.

 

Now let’s consider how old age social security fits into the equation. At presentHong Konghas two programs, the Comprehensive Social Security Assistance Old Age Scheme (CSSA) and the Social Security Allowance (SSA). The CSSA covers individuals above the age of 60 and provides a monthly payment of $3,600 (although actual payments are as high as $4,200) subject to a means test. The SSA pays $1,035 per month and is also subject to a means test for individuals aged 65-69, which is waived for those aged 70 or above. Estimates of future CSSA and SSA expenditures as a percentage share of GDP are given in Table 2. The programs referred to in the table will be explained below.

 

Table 2: Comparison of Old Age Social Security Expenditures as a Percentage of Real GDP under Different Schemes

	CSSA	Original SSA	CSSA + Original SSA	Leung’s SSA	CSSA + Leung’s SSA	Tang’s SSA	CSSA + Tang’s SSA	Chow’s SSA  + Drop Bad Son Statement	Chow’s SSA  + Keep Bad Son Statement
Hong Kong Census and Statistics Department  Population Forecasts
2011	0.32	0.36	0.67	0.56	0.87	0.74	1.05	1.54	1.02
2039	0.66	0.76	1.41	1.17	1.83	1.54	2.20	3.19	2.12
United Nations Population Forecasts
2010	0.31	0.35	0.66	0.55	0.86	0.73	1.04	1.52	1.01
2040	0.80	0.92	1.72	1.42	2.23	1.88	2.68	3.90	2.59
2070	0.80	0.95	1.75	1.45	2.25	1.90	2.70	3.88	2.58
2100	0.75	0.88	1.63	1.35	2.10	1.78	2.53	3.64	2.42

Note: The CSSA figures include only the expenditures for recipients aged 65 or above

 

We assume that the value of monthly payments will grow at the rate of GDP per capita, which implies they will rise with the average rate of improvement in the standard of living. Estimated expenditures on CSSA and the original SSA amounted to 0.67% of GDP in 2011 and are forecast to rise to 1.41% of GDP in 2039 if we assume a 4.0% growth rate for real GDP per working population and use the Census population projections. If we use the UN population projections then the percentage share of GDP will rise to 1.72% in 2040. After 2040 the percentage share falls as the proportion of elderly in the population begins to flatten out and eventually declines.

 

These figures imply there is a good chance that in 30 year’s time, spending on CSSA and SSA old age social security as a share of GDP will increase by 0.74% (= 1.41%-0.67%) to 1.05% (= 1.72%-0.67%).  Assuming our salaries and profits tax will be about 9% of GDP, then it will be necessary to raise salaries and profits tax revenues by about 8% to11% if these expenditures are to be financed wholly from these sources.

 

Leung, Tang and Chow Proposal

 

Several, more costly alternative proposals have been proposed, which I describe below. In each case I assume that the existing CSSA will remain and that future expenditure would be based on a 4.0% growth rate for real GDP per working population.

 

Mr. Leung’s campaign pledge for old age social security payments promises to provide a means-tested Special Social Security Allowance of $2,070 per month (double the amount of the current allowance). In 2011 the expenditures on CSSA and Mr. Leung’s SSA would have amounted to 0.87% of the GDP, which would rise to 1.83% in 2039 using the Census population projections. With the UN figures they would rise to 2.23% of GDP in 2040.

 

The effect of this would be that in 30 years, CSSA and Mr. Leung’s SSA old age social security expenditures as a share of GDP would have to increase by approximately 1.16% = 1.83%-0.67% to 1.56% = 2.23%-0.67% from today. It would then be necessary to raise salaries and profits tax revenues by about 13 to 18% to continue wholly financing these programs from these sources.

 

Mr. Tang’s campaign promised a means-tested Social Security Allowance of $3,000 per month. The expenditure on his proposal combined with CSSA would have amounted to 1.05% of GDP in 2011 and rise to 2.20% by 2039 with the Census population projections or to 2.68% in 2040 with the UN projections.

 

Hence, in 30 years, spending as a share of GDP on CSSA and Mr. Tang’s SSA old age social security would increase by approximately 1.53% (= 2.20%-0.67% ) to 2.01% (= 2.68%-0.67%) from today.  It would then be necessary to raise salaries and profits tax revenues by about 17 to 22%.

 

Professor Chow proposes to eliminate CSSA altogether for the elderly and replace it with a new SSA that provides monthly payments of $1,200, $2,400 and $3,600 to individuals. The lowest amount would not require a means test, but the higher amounts would.  Professor Chow also proposes to drop the requirement that recipients sign a “bad son statement” and claim that support from their children has not been received. Requiring such a statement eliminates a considerable proportion of the elderly population from claiming SSA payments. Therefore it is necessary to make separate forecasts of future old age social security expenditures depending on whether signing the statement is required or dropped.

 

Expenditure on Professor Chow’s proposal without the “bad son statement” would have amounted to an estimated 1.54% of GDP in 2011 and rise to 3.19% in 2039 with the Census population projections or 3.90% in 2040 with the UN projections. The result would be that in 30 years, spending as a share of GDP on CSSA and Professor Chow’s SSA would increase by approximately 2.52% = 3.19%-0.67% to 3.23% = 3.90%-0.67% from today.  This would mean salaries and profits tax revenues would have to increase by about 28% to 36% to wholly finance these programs. The estimates would decline significantly if the “bad son statement” were kept in place, requiring salaries and profits tax revenues to increase by about 16% to 21%.

 

Table 3: Comparison of Additional Salaries and Profits Tax Revenues Needed to Finance Old Age Social Security Expenditures in 2039/2040

CSSA + Original SSA	CSSA + Leung’s SSA	CSSA + Tang’s SSA	Chow’s SSA  + Drop Bad Son Statement	Chow’s SSA  + Keep Bad Son Statement
8 to 11%	13 to 18%	17 to 22%	28 to 36%	16 to 21%

 

Old Age versus Poverty Support

 

Comparing the three proposals, it is apparent that Mr. Leung’s is the most affordable one. Several points are worth noting. First, none of the three proposals are universal non-means tested social pension schemes. All three are basically means-tested old-age poverty support schemes, except for my fourth point below that I shall elaborate later.

Second, the impact on tax revenues is still quite substantial if not exorbitant. There will be many competing requests for spending, especially in health care and education if we wish to invest in the long-term growth of the economy. And as real GDP per capita increases over time, the old age social security payments will be adjusted as well. The faster the economy grows the more expensive the schemes become. This is because poverty is never an absolute concept in a society when there is election politics. The poverty line will be redrawn as society’s standard of living rises; such is the nature of democratic politics. This explains the paradox in the West which has insolvent social pension schemes even with sustained economic growth.

 

Third, our current SSA payments have a non-means tested component which is an anomaly in the schemes put forward. Evidently this is a legacy problem. A practical approach is to freeze this sum so that a large fraction of old age support funds will be allocated to means-tested uses. Over time this will restore the purity ofHong Kong’s old age support scheme as a means-tested scheme. It will also somewhat reduce the tax burden.

 

Fourth, removing the requirement of the “bad son statement” under one option of Professor Chow’s scheme has the effect of turning his basically means-tested scheme into a more universal scheme.

 

It is important to separate two issues – poverty and financing old age support. A great deal of discussion combines the two and confuses the real issue. The question of financing old age support is whether we should save for our own retirement or government should save for us. Until a century ago, no society had a social security system. Everyone saved for himself and primarily through the family, which provided insurance against times of adversity and arranged intergenerational transfers from children to their parents. Piety was a universal virtue in all societies.  Raising children was an important means of providing for old age support.

 

Learn From Britain’s Mistake

 

Three critical factors in the West led to government funded old age social security schemes. First, the rise of the nation state inWestern Europein the 19th century made modern governments much more efficient and effective. Government became powerful enough to redistribute income and wealth on a vast scale previously unknown to any society in history.

 

Second, industrialization and urbanization greatly increased the political power of organized labor to demand the redistribution of income and wealth. Old age social security was one of many such tools, but it has become a devastating transfer mechanism that can even bankrupt governments.

 

Third, the rise of democratic politics is both cause and effect of the previous two factors, but it can also be considered as an autonomous driver of the old age social security system. Politicians in representative governments have discovered that the combination of poverty, social insecurity, and ageing is an extremely powerful agenda for organizing political support. These three concerns converged on one single constituency – the elderly, who are among the most reliable voters in elections.

 

In 1925, British Prime Minister Neville Chamberlain introduced the Widows, Orphans and Old Age Contributory Pensions Act that promised to pay men reaching age 65 and women age 60 a pension. At that time the life expectancy of men in theUKwas 56 and women 60. When the Labor Government approved the development of the welfare state in 1945, the life expectancy of men was 64 and women 68. British politicians in the last century were seriously mistaken in their forecast of life expectancy in the future.

 

InHong Kongtoday life expectancy is 79 for men and 85 for women. The public must think twice about now allowing our politicians to follow in their footsteps.Hong Kongmay need an affordable poverty support scheme, especially for the elderly, and it should naturally be means tested. But this is very far from a universal social pension scheme whichHong Kongcannot afford to have.