Cain’s Social Security Model Risks Miring U.S. in Debt

Herman Cain, the former pizza executive surging in polls for the Republican presidential nomination, wants to replace Social Security with what he called the “Chilean model” of private pension funds. Full adoption of that model may push the U.S. deeper into deficit than Greece.

Chile’s system, introduced under the 1973-1990 dictatorship of Augusto Pinochet, diverted workers’ contributions into privately run funds, slashing government revenue over the next few decades in exchange for a reduction in state pension payments 30 years down the line.

The military regime prepared for the new system in 1981 by cutting spending, building up a fiscal surplus and clamping down on all forms of dissent. The U.S. by contrast, had a deficit equal to 8.9 percent of gross domestic product last year, the Congressional Budget Office estimates, and no political consensus on how to eliminate that shortfall.

“For the U.S. right now it would be impossible,” said Alejandro Micco, who was the chief economist at Chile’s Finance Ministry until last year. To change to a private pension system “you either need to have a very big fiscal surplus to pay retirees without income from workers, or go into debt.”

An NBC News-Wall Street Journal poll taken Oct. 6-10 found that Cain led the Republican field with 27 percent, followed by former Massachusetts Governor Mitt Romney with 23 percent and Texas Governor Rick Perry with 16 percent. The poll interviewed 336 people who said they would vote in the Republican primary and had a margin of error of 5.35 percentage points. Cain had 5 percent in an NBC-Wall Street Journal poll taken in August.

Photographer: Daniel Acker/Bloomberg

Republican presidential candidate Herman Cain, who has pledged to throw out the U.S. tax code, now says he would keep excise taxes on goods such as gasoline, beer and cigarettes. Close

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Photographer: Daniel Acker/Bloomberg

Republican presidential candidate Herman Cain, who has pledged to throw out the U.S. tax code, now says he would keep excise taxes on goods such as gasoline, beer and cigarettes.

‘Chilean Model’

Cain, speaking to the New Hampshire House of Representatives on Oct. 12, mentioned his proposal to adopt the “Chilean model, offering younger workers an optional personal retirement account” as an alternative to the Social Security system.

U.S. Social Security is mostly financed through a payroll tax that last year brought in $545 billion, 3.6 percent of gross domestic product, topped up by income from investment earnings, according to the Social Security Administration.

It’s not enough.

As people live longer, the ratio of workers paying Social Security taxes to people collecting benefits keeps falling, from more than eight workers per retiree in 1955 to 2.9 in 2010 and a projected 2.1 in 2029, according to data from the U.S. Social Security Administration. The agency expects to collect less than it spends this year and by 2036 will have run out of money.

Pay Now or Later

There is no easy solution, warns Augusto Iglesias, Chile’s undersecretary for pensions.

“It’s not a choice between having a cost and not having it,” Iglesias said in a phone interview. “It’s between paying the cost in this generation or leaving it for a future generation.”

Chile pioneered the private pension system in 1981 to build up the country’s savings rate, help develop its capital markets and reduce the long-term strain on its budget. The new system was optional for people already paying pension contributions, and compulsory for everyone joining the labor market.

Chile expects to fully replace the government program by 2030. The cost to the state of switching to the new system reached about 4.9 percent of GDP in 1984, according to the budget office.

Even in 2008, almost 30 years after Pinochet’s team of U.S.-trained economists implemented the system, pensions still represented a drain on the government finances of about 3.1 percent of GDP.

“This system is thrown out as a free lunch at times,” said Eugene Steuerle, a former Treasury Department official who is Institute Chair at the Urban Institute, a nonpartisan research center in Washington. “But if it isn’t funded, the U.S. would end up running huge deficits.”

‘Working Well’

The U.S. budget shortfall would rise above Greece’s 10.5 percent of GDP if all of the current payroll tax was diverted into private saving funds, according to Bloomberg data.

While Cain has not elaborated on how the plan would work in the U.S., his campaign rejected the idea that it could have disastrous consequences on the U.S. fiscal picture.

“We disagree with your analysis,” spokesman J.D. Gordon said in an e-mail. “Thirty countries have adopted the Chilean model, and it is working out well for those nations.”

Argentina’s government lost $37 billion from workers contributions after it set up a private pension system in 1994, seven years before the country defaulted on $95 billion in debt, according to Sergio Fiscella, a professor at the University of Buenos Aires.

The burden on the state led the government to nationalize the system in 2008, returning pension contributions to state coffers.

Fiscal Austerity

Chile’s private pension funds have done better than the government originally expected, returning an average 9 percent per year in real terms and amassing $133 billion since 1981. The fiscal austerity that accompanied the system has left the Andean nation with net credit of about 7.5 percent of GDP, compared with a debt burden of 73 percent of GDP in the U.S.

Chile has a GDP of $203 billion, according to Bloomberg statistics, and a population of about 17 million, compared with U.S. GDP of $14.5 trillion and a population of 312 million. Inflation was 3.3 percent in Chile in September, according to the National Institute of Statistics, while the U.S. Labor Department put inflation at 3.8 percent in the same month.

While Chile’s pension system has helped enforce fiscal discipline, it has also left millions without savings for their retirement and originally provided no safety net for the poor.

In 2007, only 60 percent of Chilean workers had some kind of pension coverage, down from 86 percent in the 1970s, according to a 2009 article Iglesias wrote for the Organization for Economic Cooperation and Development.

Dictatorship

“It was implemented under a dictatorship, which meant it didn’t have to pass through Congress, and it was obligatory,” said Claudio Reyes, who oversaw pensions as Iglesias’ predecessor until March 2010. “It wouldn’t have been so easy in a democracy.”

Even those in the system are not guaranteed an income to see them through their golden years. Almost half of affiliates aged between 60 and 65 have less than 5 million pesos ($10,000) saved up, according to the latest figures from the Superintendent of Pension Funds. That’s not enough live on for a year and a half, based on Chile’s average monthly salary of 338,000 pesos.

“People had to put off retirement because the pensions they were due to receive couldn’t maintain their quality of life,” Reyes said.

Chilean Reform

Jose Pinera, brother of Chile’s current President Sebastian Pinera, designed the pension system when he was Pinochet’s labor minister. He now travels around the world touting its benefits, with London’s Sunday Telegraph calling him the “pension world’s equivalent of Placido Domingo” in 1996. He declined to be interviewed for this article, citing engagements in Europe.

Twenty-seven years after starting the system, Reyes and Chile’s government felt the need to reform it. In 2008, they started a minimum pension for people who had made contributions for 20 years and raised payments for people who had no pension provisions.

“The Chilean model has faults, some of which have had to be solved by the intervention of a well-funded state,” Reyes said.

-- With assistance from Eliana Raszewski in Buenos Aires and Julie Hirschfeld Davis in Concord, New Hampshire. Editors: Philip Sanders, Joshua Goodman

To contact the reporter on this story: Sebastian Boyd in Santiago at sboyd9@bloomberg.net.

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net.

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