GEO

Ten Remarks on Pension Reform

01 March, 2018

The Parliament of Georgia is currently considering a draft law on "Defined Contribution Pensions” that aims to introduce new mandatory defined contribution (DC) pension schemes in Georgia from July 1, 2018. Participation in this scheme will be mandatory for all hired employees less than 40 years of age. They will be required to direct 2% of their earnings to their retirement savings and employer will add the same amount. The state also will be obliged to contribute by 2% of employees earnings that are less than GEL 24 000 per year, and 1% for the amount between GEL 24 000 and GEL 60 000. Participation in this scheme will be voluntary for self-employed; and for those hired employees who are older than 40 years. 

The Pension Agency, LEPL will be in charge of administration and implementation of new pension schemes. The Investment Council will be responsible for management of assets and, based on risk assessment, will decide where to invest the savings.

Remarks and Risks

  1. According to the 2016 election program (pg. 6) of Georgian Dream and 2018-2020 Governmental program (pg. 19), ‘’Regulatory Impact Assessment (RIA) will be widely practiced that will allow us to analyze potential impact of each decision on business”. Georgia-EU Association Agreement (article 225) also urges Georgia to practice RIA. Despite taken commitments, the draft law on pension reforms has been submitted to the Parliament without conducting RIA. This reform can bring significant risks for country development since it is not obvious whether benefits exceed costs, therefore, such steps should not be taken without comprehensive analysis. 
  2. The Government of Georgia (GoG) argues that the proposed pension system is based on best international practice. However, it is important to name at least one country the pension system of which is the most similar to Georgian model. It is noteworthy that even in couple of EU member states mandatory contributory pension systems have not succeeded much (For instance, Hungary, Poland).
  3. To obligate an employer to transfer 2% of hired employees’ salary, who are older than 40 years, to pension funds is, in fact, taxing and might contradict with the Constitution of Georgia. According to the Constitution, introduction of a new tax, except an excise, requires public referendum.
  4. The proposed pension scheme cannot ensure so called “Deserving Pension” due to couple of reasons. Hired employees encompass only 25% of total work force, 34% is self-employed and 41% of population is either unemployed or outside the workforce. In addition, 58.4% of all employees are older than 40 years who are not obliged to participate in the proposed pension scheme. As a result, the mandatory defined contribution pension schemes will cover only 10.55 of adult population of Georgia.
  5. Existing low wages cannot ensure so called “Deserving Pension”. An average salary of hired employee is approximately GEL 1000. If we assume that, during the following 25 years, real wages will annually increase by 5% and the savings will have 5% of annual return, after retirement an average person will get only GEL 210 monthly for 15 years. The GoG says that the current social pension (GEL 180) will be kept at least on the same level by indexing it. Therefore, after 25 years an average real pension will be GEL 390 per month that is only 20 and 12 percent replacement rate of an average salary and the last salary paid after 25 years, respectively. Just to compare, today the replacement rate is 18%. Moreover, salary of more than half of hired employees does to exceed GEL 500, thus, based on above assumptions, in 25 years their monthly pension will be only GEL 306 that is only 25.5 and 15 percent replacement rate of an average salary and the last salary paid after 25 years, respectively. Just to compare, today the replacement rate is 30%.
  6. The proposed pension system will further increase social inequality since the state will eventually contribute more to hired and high-income employees than to unemployed and low-income population. Therefore, social inequality, ceteris paribus, will increase.
  7. The proposal will also increase burden on employers (in fact, income tax will increase from 20% to 23.2%) that will lead to more expensive workforce and less employment. Therefore, it can have a negative impact on business environment.
  8. The proposed pension system can also stimulate emergence of informal employment practice and shadow economy.
  9. New initiative will also increase financial burden on the state budget (its 1-2% will be contributed). If we also take into account that the existing social pensions will also be kept at the current purchasing power level, maintenance of such costs in the current political context could be impossible. Based on good foreign practice, fiscal risks stemmed from introduction of defined contribution pension schemes are insured by slowing the pace of social pension rise. The GoG has not expressed such readiness yet. 
  10. Minimal consensus on the proposed pension reforms among political parties and society is almost absent.

Recommendations

  1. The Parliament of Georgia should not adopt the proposed draft law on pensions without conducting comprehensive RIA. The RIA should include analysis of various scenarios that can show potential advantages and shortcomings of current and proposed pension schemes. Other types of mandatory and non-mandatory defined contribution pension schemes should also be considered.
  2. In order to avoid rising employment costs, unemployment, and reduction of current net income, the pension contributions could be compensated by decrease of income tax rate. This will also exclude the risk of violating the Georgian Constitution.
  3. New defined contribution pension schemes should be voluntary and the state should create tax stimuli for employees to participate in it. According to the recent public opinion polls, 65% of population supports non-mandatory pension schemes.
  4. Pension reform can have significant irreversible impact on country development; therefore, further public discussions with all stakeholders are crucial for ensuring higher public trust and long-term sustainability.

Transparency International Georgia

PMC Research Center

Georgian Young Economists’ Association

Economic Policy Research Center (EPRC)

Georgian Reforms Associates (GRASS)

Georgian Democratic Initiative (GDI)

Governance Monitoring Center (GMC)

Giorgi Papava (Associate Professor, Ilia State University Business School)

Irakli Kipiani (An economist)

Archil Jacobashvili (Full Professor, GAU Business School)