Portugal

Introduction

Just like any other part of the world, Portugal has a well-established social security system, which many of her people depend on for their welfare. Like in the US, social security system in Portugal covers a wide range of programs. Some of these programs include retirement pension scheme that covers employees from both public and private sectors, social assistance program that includes benefits for the unemployed and their dependencies among other programs.

The social security system in Portugal experiences problems such as non-contributory coverage, dealing with many survivors and disability beneficiaries (Barrows 25). Generally, the system experiences a problem of dealing with large number of people requiring assistance – an unrelenting problem that seems to affect many of the social security systems across the world.

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Large proportion of inflow comes from PAYE funds, as it is the case of the United States. Taxes from the payroll can be termed as the backbone of the Portuguese social security system; however, there is a problem based on ‘baby boomers’ experience. After Second World War, populations across Europe blossomed and such large populations joined the social security systems, which also thrived.

However, as the ‘baby boomers’ generation approaches retirement, the current working population is smaller and cannot sustain the current social security system, firmly established by the ‘baby boomers.’ Moreover, many contributors do not see any positive relationship between what they contribute and what they get at the end of the day. Indeed, according to many employees, the taxes reduce their private savings and disposable income and hence the capital formation.

This paper will analyze financial sustainability of the Portuguese social security system mainly by comparing the revenue contributed and the cost required to maintain it. The research will use secondary data to analyze the trend of income and expenditures of the system for a period of fifty years from 1999 and 2050.

Background Literature

Social security system in Portugal comprises of three components; family allowances benefit systems and social welfare allowances for citizens. The allowance component compensates citizens when their earnings decline due to the following reasons; unemployment, sickness, disability, death, old age, and work accidents just to mention a few. Employees, both self-employed and the employed, benefit from this system.

Non-working and unemployed individuals however, have the right to subscribe if they so wish. For one to enjoy the benefits of social security system, he/she must meet two conditions. First, one must register and secondly, the individual must meet his/her monthly contributions just like the employed.

Though the Portuguese social security system has improved over the years, it continues to face many problems. Financial instability is the major problem. Those people who contribute each month to the social security system suspect misappropriation of these funds; hence, they do not get the expected benefits from this scheme. Many employees would therefore prefer some structural reforms in the system for it to meet their needs effectively. Portugal needs to change her current scheme of ‘pay as go used go’ and adopt a capitalization system.

In this type of system, every employee has his or her own account where all the contributions made goes into this personal account. When the employee attains the age of retirement, then he or she can withdraw all the money deposited in the personal account. This will help to address dissatisfaction by many employees who question the efficiency of the current system. As Barrow claims, capitalization regime will ensure direct relationship between the benefits and contribution.

This will eliminate the perception that the contribution to the social security system is just as tax deducted on the labor income (26). Capitalization regime will ensure that there is no sharing of the social security system’s funds from one single pool. Every employee will sustain his or her pool and in case of anything, he/she will withdraw the money from the personal account.

Failure to do that will perpetuate the worsening the financial position of the system as more and more beneficiaries depend on insufficient funds contributed by just a small proportion of the population now and in future. As Pereira da Silva, Calado, and Maria put it, there is a looming financial problem facing the social security system in Portugal; the government needs to address it urgently before it gets out of hand (418).

There is a large gap between the benefits and the declining rate of contribution and subscriptions. The active population does not benefit from their huge contributions to the social security system. The founders of the Social security trust fund in 1995 aimed to reinforce the social security system, but this has not solved the problem of financial instability.

The government also introduced partial capitalization program in 1989 in which it invested the contributed funds in the different ways such as in financial markets. This also aimed to stabilize the financial status of this system. The returns from these investments would cater for future raise in costs. According to Pereira da Silva, Calado and Maria these stabilization funds created by the government are not in a position to counter the financial challenges facing the system and therefore it ought not to be the focus of the stakeholders (418).

As mentioned earlier in the research, it is not Portugal alone whose social security systems are facing challenges. Yasar argues that social security systems in US also face the same challenges. Economists attribute the US challenges to the increased number of baby boomers attaining the age of retirement (843).

Currently the debate is going on in US among the reformers and other groups over the appropriate reforms in the social security system to meet the raising demand of beneficiaries. Reformists are advocating for the change of the system and adoption of a fully funded retirement plan with clear definitions. Other groups are arguing that demographic problems, which justify the privatization of the system, are wrong.

Irrespective of which group is right, the fact remains that there is a challenge in the social security system in US which may even become worse in the future as more and more people attain the age of retirement. Puckett argues that managing social security system is a challenge not only for today but also for yesterday and tomorrow (25).Thus even as we analyze the case of the Portuguese social security system it is important that we have it in mind that these systems are facing challenges in all the parts of the world.

Data

To analyze the financial sustainability of the social security system in Portugal, this study will use secondary sources of data mainly from the international association for the study of insurance economics 2004 among other sources. This study chose these sources of the data for various reasons, which include; first, the sources are reliable and thus provide reliable data for valid conclusion.

Secondly, this data is very relevant to the topic of the study since it provide all the required information about the Portuguese social security system. Data about the contributions and distribution of benefits in this social security system is very relevant to this study, which these sources adequately provide.

This data will make it easy to analyze financial sustainability of the Portuguese social security system by comparing the rate of growth of revenue collected from the citizens and growth rate of the fund’s beneficiaries. The data clearly portrays the gap between the rate of fund’s growth and cost rate for easier comparisons. The data also compare the difference between synthetic cost and income rate, which helps to predict the future of this social security system.

The data also helps to show the projected accumulated funds as well as the growth trend for the next forty or so years. This will help to show or measure whether this system will become more sustainable or less sustainable in future. In addition, this data will help to show the account of the social security benefits to the current and future’s GDP of Portugal. All this will assist in coming up with a valid conclusion in this research.

Research analysis

From the various tables given in this research, it is possible to observe the trend of social security system in Portugal. To start with, Table 1 shows the comparison of rate of revenue and rate of cost from 1999 to 2050. From this table, we can observe the following; accumulated asset funds will attain their maximum level by 2012 where the rate of revenue growth will be approximately 0.285 per cent.

The rate of revenue has been growing consistently from 1999 though by a small margin until 2012 when it reaches the maximum point. Thereafter the growth rate of revenue starts to decline from maximum level attained in 2012 to about 0.26 percent by the year 2020. This trend remains constant for the next 30 years; table predicts the same rate of revenue growth by 2050.

Contrary to growth rate of revenue, the cost rate grows steadily throughout the research period and there is no record of decline in growth. The growth in cost rate in 1999 is 0.24 per cent and continues to grow consistently year after another until it reaches a maximum level of 0.36 percent by 2050. The current growth rate of revenue is 0.34 percent, which is a large increase from 0.24 percent in 1999. This rate does not fluctuate much in the next forty years since the projected growth in the rate of cost by 2050 is 0.36 per cent.

Again, this table notes the trend in differences of cost and revenue. From 1999 to 2005, the rate of growth in revenue exceeds the rate of growth in cost. This means that during this period, the rate of growth of contributions collected in the system was less that the number of beneficiaries.

However, from 2008 onward, the rate of growth of cost is more than the rate of growth of revenue. This means that the rate of growth of beneficiaries of the social security funds is exceeding the rate of contribution. This may lead to financial problems in the system.

Results explanation

The data portrayed in this table shows a move from equilibrium to disequilibrium since 2008. There is acute imbalance between the growth rate of contributions and beneficiaries of the social security funds. The data shows that before 2008, the system was sustainable and it could support all the beneficiaries since there was more revenue than cost.

When the beneficiaries started to exceed the contributors in 2008, the financial however instability started. Though the country never experienced population boom like other countries, which had participated in the Second World War, the number of children born after the war were many.

This generation started attaining the age of retirement in 2010. Predictions show that this trend is likely to remain for the next ten years. This has already started exerting pressure to the social security system funds since the amount going out is more than the amount coming in.

The subscriptions and contributions have already started to decline as more and more members continue to retire. By 2025, economists expect that the benefits of the funds will not be enough to cover all the benefits, management and the administration costs. Further projections show that by 2050 this deficit may reach to about 38.5 per cent.

This will be equivalent to about 2.25 percent of the country’s total GDP. This means that to minimize this deficit, there is need for some action to close the gap between the rate of revenue and costs. Two options are possible, either to increase the rate of contributions or decrease the rate of expenditures. The government may reduce the rate of expenditure by 0.7 percent or increase contribution rate by 10 per cent in order to attain equilibrium by 2050.

These two options are possible but not easy especially on the side of the government. For instance, to increase the rate of contribution, government will need to improve its efficiency in recruiting and collecting more contributions from the citizens or coming up with a legal provision that will raise the amount contributed by each member.

The latter will have an opportunity cost to the economy in terms of savings and investments. The government may also consider implementing the two methods simultaneously to increase the amount of contribution to the social security system. The second option of reducing the expenditure by 0.7 percent will also be costly to the government and the citizens.

Lowering the benefits may result into suffering of some people. Members of the social security schemes may not get the expected amount after retirement even after dedicating themselves to contribute during their working days due to shortage of the funds. The system may not be able to finance fully some cases such as accident, sickness, and maternity of the active contributors due to this policy. This option will also have some consequences, which may be too costly to the members and the government.

Further analysis

Table 2 compares the rate of fund’s growth with the ratio of the fund. The rate of fund’s growth reaches the maximum point in 2005 and starts to decline consistently until it reaches the lowest point in 2020 where it shows a negative growth. From there the growth rate remains constant at 0 percent showing no growth in the next thirty years up to 2050.

The ratio of the fund grows consistently until it reaches a maximum in 2011. It then starts to decline until it reaches 0 percent in 2035. The high rate of unemployment is the attribute to the decline of the growth rate of fund. Increased number of employees who are retiring can also lead to low contribution rate. At the beginning, the fund ratio is high since the number of people remitting their contribution is increasing but later the trend decrease as more people reach their age of retirement.

Table 3 compares the rate of growth of synthetic effective income and synthetic effective cost. Synthetic effective income increases steadily until it reaches a point where it starts to decline. It manifests the highest rate in 2040 and thereafter it starts to decline. The rate of synthetic effective cost increases steadily and reaches the maximum (30 percent) by 2050. The difference between the two rates decrease from positive side and then start to increase steadily on the negative side.

Effective income rate shows “taxable payroll to the income ratio and it will increase so long as the income of the employee is increasing” (Puckett 76). As a result, the rate increases despite the cost increase. The effective rate of cost shows the ratio of taxable payroll to expenditure and continues to increase steadily so long as the expenditures are increasing. The differences between the two rates change due to fluctuating income and expenditure for the entire research period.

Summary and conclusion

From this study, it is evident that the current social security system in Portugal is not sustainable. The analysis of the data shows that by 2050, the deficit in the system will have risen to 38.5 percent, a significant proportion of the total GDP of Portugal.

The gap between the growth rate of revenue contributed and the cost demanded from the funds has continued to increase over the years and projections show its increase in future. This condition may be attributed to high rate of retirement as large proportion of the population, which was born after Second World War, currently attain the age of retirement.

Other factors such as high rate of unemployment have contributed to this problem; there are few people joining the system to increase the revenue collection. The government has come up with various programs to address the problem; however, the outcome is of little significance. Initiatives such as investing the contributed funds in various ways have not helped much in addressing the problem.

To address the problem, the government may either look for ways to increase the contributions such as recruiting more members and increasing the rate of contribution per member or coming up with ways to reduce the expenditure of the social security system. The two options are not easy for the government given that they have their opportunity costs in terms of saving and investment.

However, an urgent action is necessary to prevent the situation from deteriorating in future; actually if unchecked, the situation will degenerate into a crisis and the retiring will go home uncompensated as the system crumbles under the weight unsustainable demands due to poor policymaking. Nevertheless, a swift well-planned and executed strategy will ensure that the social security system in Portugal is sustainable for now and in future.

Works Cited

Barrows, Jen. “Portugal’s Social Security System: The Efficacy of Reforms.” Yale Economic Review 6.1 (2010): 25-27. Print.

Pereira da Silva, Carlos, Calado, Joao, and Maria, Teresa.“The Financial Sustainability of the Portuguese Social Security System.” Geneva Papers on Risk & Insurance – Issues & Practice 29.3 (2004): 417-439. Print.

Puckett, Carolyn. “Administering social security: challenges yesterday and today.” Social Security Bulletin, 70.3 (2010): 27-78. Print.

Yasar, Yavuz. “It’s the Prices, Stupid: The Underlying Problems of the U.S. Social Security System.” Journal of Economic Issues (M.E. Sharpe Inc.) 43.4 (2009): 843-865. Print.