THE FINANCIAL EXECUTIVE
Business World
Last part
The PERA also serves as a pilot test for the mandatory defined contribution pillar of a multi-pillar pension architecture1.
Under the proposed architecture, the defined benefit second pillar, currently consisting mainly of the pension programs of the Social Security System (SSS) and Government Service Insurance System (GSIS), will be downsized while a mandatory defined contribution third pillar will be established to supplement retirement income provided under the second pillar. The third pillar will essentially be an enlarged PERA system.
Mandating it puts the burden of prudent regulation on government, which will have the opportunity to learn the "tricks of the trade" during this test period and work on strengthening oversight.
Successful reform of the pension system is important from both capital market development and fiscal sustainability perspectives.
As it is, the pension institutions, particularly SSS (not to mention RSBS!), are financially sapped and are at risk of becoming net takers instead of providers of funds to the capital market.
In fact, based on actuarial studies made in 1999, the SSS is projected to start drawing down its reserves as early as 2008, with its reserve fund running out by 2015. If nothing is done to stop the bleeding, the National Government would eventually have to step in to fulfill its guarantee of the pension obligations.
In 1999, the implicit public debt (the cost of accumulated pension obligations) associated with the SSS (based on a status quo on current policies, especially the level of contribution rate and benefit entitlements) was estimated at P1.5 trillion (about 50% of GDP) and must be significantly higher by now. This very real fiscal risk should override any concern over short-term tax losses.
At the end of the day, the truly binding constraint to Philippine capital market development has been and will be the paucity of available long-term savings and savers.
A fully functioning third pillar will help build up domestic savings needed to broaden and deepen the local capital market, providing savers with more investment choices and firms with access to long-term peso-denominated financing. That is the long-term vision. PERA takes us one step closer.
1The proposed multi-pillar pension architecture considered by the World Bank's "Averting the Old Age Crisis" as international best practice consists of: a redistributive social assistance first pillar, a mandatory defined benefit second pillar, a mandatory defined contribution third pillar, and a voluntary private pension fourth pillar.
Friday, April 15, 2005
Thursday, April 14, 2005
PERA: A step towards pension reform
THE FINANCIAL EXECUTIVE
Business World
Opposition to the Personal Equity Retirement Account (PERA) bills in the Finance department and among some members of Congress appears to stem from fears that the favorable tax treatment accorded these accounts would reduce government revenues at a time when government is working overtime to legislate new taxes. First of all, the argument goes, tax deductibility of contributions will reduce the personal income tax base. Secondly, in all likelihood, there will be no "new" savings. Rather, funds will merely migrate from taxable accounts where they are currently held, to PERA products where they will be tax-exempt (or deferred).
These arguments are not unreasonable. The tax exemptions are after all, key features of the bills. The PERA is also entirely voluntary and chances are, prospective contributors have already formed the habit of saving and are simply seeking higher net returns on their savings. Nonetheless, judging PERA by the amount of taxes it deprives government today is myopic.
To appreciate the significance of the PERA bills, one should focus instead on the potential contribution of PERA to long-term fiscal sustainability and capital market development. The way I see it, PERA is a first step to harmonized financial regulation and pension reform, both necessary conditions for capital market development. Pension reform, particularly containment of unfunded pension liabilities, is likewise critical for long-term fiscal stability.
How can PERA lead to harmonization of tax and regulatory regime? As envisioned, funds contributed into PERA may be invested in a host of savings instruments, including stocks, bonds, mutual funds, bank deposit products, etc., which ideally should receive similar tax treatments so that investment decisions are not made on the basis of differential taxation. It is also expected that different financial institutions (e.g., banks, insurance companies, investment houses, mutual funds), supervised by different regulatory institutions (i.e., the Bangko Sentral, Insurance Commission, SEC), will be offering PERA products; thus the need to define a single product jointly and uniformly regulated by the three. Only with a sound regulatory framework, including equal application of tax and accounting standards, can another pre-need fiasco be avoided (in this case, it will take even longer - over 40 years from work-age to retirement versus 16 years for educational plans - to discover any anomalies) and confidence in PERA be engendered.
Business World
Opposition to the Personal Equity Retirement Account (PERA) bills in the Finance department and among some members of Congress appears to stem from fears that the favorable tax treatment accorded these accounts would reduce government revenues at a time when government is working overtime to legislate new taxes. First of all, the argument goes, tax deductibility of contributions will reduce the personal income tax base. Secondly, in all likelihood, there will be no "new" savings. Rather, funds will merely migrate from taxable accounts where they are currently held, to PERA products where they will be tax-exempt (or deferred).
These arguments are not unreasonable. The tax exemptions are after all, key features of the bills. The PERA is also entirely voluntary and chances are, prospective contributors have already formed the habit of saving and are simply seeking higher net returns on their savings. Nonetheless, judging PERA by the amount of taxes it deprives government today is myopic.
To appreciate the significance of the PERA bills, one should focus instead on the potential contribution of PERA to long-term fiscal sustainability and capital market development. The way I see it, PERA is a first step to harmonized financial regulation and pension reform, both necessary conditions for capital market development. Pension reform, particularly containment of unfunded pension liabilities, is likewise critical for long-term fiscal stability.
How can PERA lead to harmonization of tax and regulatory regime? As envisioned, funds contributed into PERA may be invested in a host of savings instruments, including stocks, bonds, mutual funds, bank deposit products, etc., which ideally should receive similar tax treatments so that investment decisions are not made on the basis of differential taxation. It is also expected that different financial institutions (e.g., banks, insurance companies, investment houses, mutual funds), supervised by different regulatory institutions (i.e., the Bangko Sentral, Insurance Commission, SEC), will be offering PERA products; thus the need to define a single product jointly and uniformly regulated by the three. Only with a sound regulatory framework, including equal application of tax and accounting standards, can another pre-need fiasco be avoided (in this case, it will take even longer - over 40 years from work-age to retirement versus 16 years for educational plans - to discover any anomalies) and confidence in PERA be engendered.
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