This paper argues that the brunt of the reform-induced increase in Poland’s social expenditures has been borne by social insurance arrangements (mainly pensions and unemployment compensation) rather than by social assistance schemes targeted to the poor or by more temporary schemes, largely because of the ease of access to social security and its more attractive benefit structure. A major policy challenge for Poland will be to avoid a further burdening of social security by needs that should be addressed through basic income support and emergency assistance policies or general transfers (e.g., family allowances). The paper illustrates current reform needs, using unemployment compensation and pensions as examples.

As regards unemployment compensation, the introduction of flat-rate benefits and duration limits has addressed some major concerns, but others remain to be resolved. These include the administration’s capacity to enforce existing rules, the problem of adjusting benefits to inflation, the limited use of active labor market measures given that labor mobility is constrained by a severe housing shortage, and issues of fiscal federalism that arise as the local authorities are forced to take on more responsibility for the long-term unemployed.

As regards pensions, it is estimated that, without reform, costs of the current pay-as-you-go system will continue to increase significantly and further threaten the financial viability of the system, notwithstanding Poland’s relatively favorable demographics. Five tasks demand policymakers’ immediate attention. First, the average retirement age should be increased from the current 55 years to over 60 years, for example by reducing the high number of disability pensioners, limiting benefits to early retirees through actuarial adjustments of pension benefits, and further restricting the right to, and enforcing existing rules regarding the simultaneous receipt of, pension and wage income. Second, the problem of contribution evasion and arrears needs to be addressed by increasing enforcement authority and capacity. Also, introducing employee contributions may help to make employees more interested in their employer’s compliance.

Third, there is no room for special treatment of specific occupational groups in the form of discretionary adjustments in the pension base or highly favorable early retirement provisions. Fourth, benefits that do not address social security contingencies, such as family allowances, should not be financed through contributions and paid from the pension funds, but financed from general taxation and paid directly from the budget. Finally, the mechanism for indexing pensions remains flawed. If the pension system is frequently hard-pressed to meet its payment obligations, nominal entitlements must change.

As regards more systemic reforms, a public two-tier pension system, with a flat-rate minimum pension as the first tier and a defined-benefit second tier, none of it covered by a budget guarantee, would probably serve the country best. More radical, Chilean-type reforms should not be considered because they have strong budgetary implications, particularly in the short to medium term, and could easily increase macroeconomic imbalances.