Brazil: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
15 Nov 2016
eISBN:
9781475553222
Language:
English
Keywords:
ISCR; CR; futures intervention; credit; central bank; income; labor market; pension expenditure; Previdência Complementar; health expenditure rule; pension system; Pensions; Health care spending; Global
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Brazil: Selected Issues

Abstract

Brazil: Selected Issues

Fiscal Challenges of an Aging Population in Brazil1

In recent decades, the elderly population has doubled in Brazil while pension and health related spending has increased in per capita terms and as a share of GDP. As the demographic profile changes, spending on health and pension will increase to unsustainable levels absent reforms to benefits. These reforms should start as soon as possible, so that they can be implemented gradually to ensure sustainability and population endorsement.

A. Overview

1. In recent decades, the elderly population has increased substantially in Brazil. Declining fertility rates and increasing life expectancy are important drivers of demographic changes in Brazil and Latin America, which have contributed to decreasing population growth and a growing share of elderly citizens in the total. Over the past half a century, fertility rate in Brazil and other middle-income countries has halved and is now in line with that of advanced economies (Figure 1). Annual population growth has thus declined dramatically. Meanwhile, thanks to income growth, redistribution policies, and health reforms, life expectancy has increased in Brazil, pushing up the dependency ratio. Population aged 65 and above constitutes now about 7½ percent of the total population, up by two percentage points from only a decade ago.

Figure 1.
Figure 1.

Demographic Indicators, 1960–2014

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Source: World Development Indicators, The World Bank.

2. The demographic trends are set to continue, further increasing dependency ratios. Because of declining fertility, the population will start declining in absolute terms in Brazil by mid-century. According to the UN, by 2050 Brazil’s old-age dependency ratio—the ratio of citizens aged 65 and above to the ratio of population aged 15 to 64—will reach close to 37 percent, and surpass that of more advanced economies by 2100. Brazil’s statistical institute (IBGE) projects a similar trend, with old age dependency reaching 36 percent by 2050.2

3. An aging population will soon pose fiscal challenges in Brazil, much earlier than in 2050. Public age-related spending (on pensions and health) is projected to reach levels incompatible with fiscal sustainability already within the next decade. Pension and health expenditures represent half of total public spending in 2015 (16 percent of GDP) and, if the current generosity of benefits is left unaddressed, are projected to increase to 21 percent of GDP in 2025 and 40 percent of GDP by 2050 as the elderly share of population more than triples. However, unlike in other countries, where demographic disequilibria point to difficult times down the road, the Brazilian pension system is already in deficit, which is projected to reach 3.2 percent of GDP in 2016 (Tesouro Nacional, 2015).

4. Past reforms moderated pension deficits for a time, but urgent attention to ageing-related spending is needed once again. The 1998 pension reform had a limited impact on deficits, and in 2003 parametric changes were introduced in the mandatory public sector pension regime. In 2012, a defined contribution pillar for the public regime was established which reduced replacement rates for higher earners and enhanced progressivity and equity with respect to private pensions at a relatively low transition cost The macroeconomic impact of the reform was estimated to be positive for Brazil, increasing private savings and labor supply, especially if financed through increased government savings (IMF, 2012). However, these reforms were insufficient, and will not contain the growth of pension spending ahead. In the area of health, limited consideration was given to efficiency and cost control until recently, although spending had increased massively over the last few decades to fill the gap in coverage and health outcomes with respect to advanced economies.

5. Several options for reform are explored in this paper.

  • Pensions. A combination of reforms to reduce benefits eligibility are considered and have the potential of containing future deficits in the least distortionary way for labor incentives. Delaying retirement would ensure significant fiscal savings but is only a starting point. Changing the benefits indexation formula and removing existing payroll tax exemptions are also important measure and could be complemented by a benefit freeze to existing pensioners to frontload the savings.

  • Health. Cost-containment in health is an unexplored area in Brazil. The experience of advanced economies provides insights on approaches to contain the growth of health spending. The effects of these reforms are difficult to quantify, however, and trends in longevity, evolving standards of care and the introduction of new technologies create new demands on health systems. This underscores the need to continuously refine approaches to achieve efficiency gains in the provision and utilization use of health services.

Reforms to age-related spending programs should start now so that they can be gradual.

B. Brazil’s Pension and Health Systems

The Pension System

6. The Brazilian social security system offers a full menu of benefits, including old age, disability, and survivors’ insurance, as well as early pensions. The institutions that offer retirement pensions also provide maternity benefits and worker’s compensation, without requiring individuals to make separate contributions.

7. The core of Brazil’s pension system consists of three main defined-benefit public schemes and a number of private, mostly voluntary, defined-contribution schemes.

  • The mandatory system, known as Regime Geral de Previdência Social (RGPS), is a public system with 53 million contributors covering some 30 million beneficiaries in the private sector, and disburses 7.1 percent of GDP in pensions (2015 estimate). Benefits are financed from employee contributions (8–11 percent on wages), employers’ contributions (20 percent), the COFINS tax and a profit tax— CSLL.3 The RGPS receives regular transfers from the budget. Private sector employees can retire at age 65/60 (men/women) after 15 years of contribution (“Age”), or irrespective of the age with full contribution history—35/30 for men/women (“Contributory”).4 Old-age benefits are the largest expenditure within the RGPS (Age + Contributory in the figure), both by number of beneficiaries and total value of benefits, but survivor’s and invalidity pensions are also important. There are 13 pension payments per year, which are indexed annually to inflation, except for those equal to one minimum wage (see below). There is another benefit within the RGPS called Previdência Rural (rural pension) for males/females aged 60/55 or older, who have completed at least 180 months of work in rural areas. The benefit is equal to the minimum wage (OECD, 2015). In 2015, about 9 million beneficiaries received a rural pension, representing approximately 31 percent of all recipients of pensions. The rural program represented 20 percent of the Government’s pension expenditures or 1.7 percent of GDP in 2014.

  • The Regimes Próprios de Previdência Social (RPPS) applies only to workers in the federal, state, and municipal governments: civil servants, the military, the judiciary, congressional staff, school teachers, and the police. It covers 1.5 million of beneficiaries, and disburses about 4 percent of GDP. Municipal, federal and state entities manage their own schemes for their employees, but are jointly coordinated by the Ministry of Pensions and Social Assistance. In general, these pension plans are financed on a pay-as-you-go basis with the employee paying a percentage of their salary.5 At least 10 years of work within the government are required to qualify for a pension. The pension benefit formula takes into account the highest salaries from positions the member held for at least five years. To be entitled to a full public-sector pension benefit, the statutory retirement age is 60 for men and 55 for women (this applies to members who joined the system after the 1998 reform, while those who were already employed in the public sector in 1998 are subject to easier eligibility requirements—53 for men and 48 for women). Compared to the private-sector employees enrolled in RGPS, public-sector employees enrolled in RPPS receive higher pensions against lower contribution rates.

  • Pension-like assistance benefits are also available to those who do not qualify for a retirement benefit on the basis of the systems mentioned above. The Benefício de Prestação Continuada (BPC) was created to assist old-age people (65 years old and more, both male and female) or disabled people whose household income per capita is under one-quarter of the minimum wage (floor). They receive an amount equal to the minimum wage and their conditions are reviewed every two years. The operational side of the scheme is administered by the INSS (medical certification and means-test), but the responsibility for the benefit is given to the Ministry of Social Development and Fight Against Hunger (MDS). In 2015, nearly 1.8 million received a BPC, representing approximately 6 percent of all recipients of pensions. The BPC program represented 4 percent of the government’s pension expenditures or 0.3 percent of GDP in 2014.

A03fig01-1

RGPS Benefits, 2015

(Percent of total value)

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Table 1.

Key Parameters of the Brazilian Pension System, 2015

article image
Sources: Tesouro, MPS, and IMF staff estimates.

Workers in the federal, state, and municipal governments: civil servants, the military, the judiciary, congressional staff, school teachers, and the police.

For workers joining the civil service after 2004.

8. There are also voluntary private schemes. Under the Regime de Previdência Complementar (RPC), both occupational and personal pensions are provided on a voluntary basis. Two pension vehicles exist that can be used to finance private pension benefits. Closed private pension entities are non-profit organizations that can be established on a single-employer or multi-employer basis and by labor unions. In addition to the closed approach, which is predominantly chosen by large employers, authorized financial institutions provide complementary pension provision through open private pension systems.

9. The RGPS has complex redistributive effects. The redistribution is mainly achieved by exemptions from contributions and reduced contribution rates for low-wage earners and certain sectors. Moreover, by law, no pension can be lower than the minimum wage, which is also adjusted annually (it was R$880 in 2016). As of 2015, about 67 percent of individual benefits paid by the RGPS corresponded to 1 minimum pension and were thus indexed to minimum pension growth (Credit Suisse, 2016). However, redistribution is not necessarily progressive: the RGPS covers the more affluent share of the population, those who have been employed formally and have contributed to the system for at least 15 years. Moreover, as life expectancy of the better-off share population is higher, the NPV of benefits that accrues to them is also higher. Other features of the RGPS may also suffer from poor targeting, such as the non-contributory rural pensions for instance, but this area is outside of the scope of this study.

10. Past reforms have been insufficient to contain pension spending growth and have left unaddressed important challenges. Over the past two decades Brazil has made adjustments in some pension plans to reduce outlays. These adjustments included the 2003 reform of the RPPS for new entrants, the introduction of the fator previdenciário for the beneficiaries of the RGPS in 1999, and its subsequent replacement with a progressive 85/95 formula in 2015, and the tightening of the criteria for survivor benefits in 2015 (Box 1). Three major challenges remain, however:

  • The average retirement age is low by international standards—54 in Brazil compared to 64 on average in the OECD (Queiroz and Figoli, 2010).

  • Spending on pensions in percent of GDP is high relative to the share of elderly in the population (Figure 2 and Table 2).

  • Benefits are growing faster than revenues, because of aging population, limited incremental gains from labor formalization, and the connection between the value of pensions and the minimum wage formula that pushes pension spending growth above GDP growth.

  • The multiplicity of pension systems increases inequities and puts pressure on overall pension spending due to overlapping benefits.

Figure 2.
Figure 2.

Pension Expenditure and Share of Elderly

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: World Development Indicators; and IMF Staff estimates.
Table 2.

Benchmarks of Key Indicators

article image

Recent Changes in Retirement Incentives

In 1999, a law introduced into the RGPS an actuarial coefficient called fator previdenciário (fator) whose use would be optional in the calculation of pensions in case of retirement on the basis of age, and mandatory in the calculation of benefits based on the retirement on the basis of length of contribution. The fator increases with the insured’s contribution rate, contribution period, and age, and decreases with life expectancy. In the case of retirement on the basis of age, the benefit was equal to the average of the highest 80 percent monthly earnings multiplied by 70 percent plus 1 percentage point for each set of 12 months of contribution (capped at 100 percent) and multiplied by the fator—only if this factor was higher than 1.0. For the retirement on the basis of length of contribution, the benefit was the average of the highest 80 percent monthly earnings multiplied by the fator.1

f=Tc*tLe*[1+(Age+Tc*t)]100

Where: f—fator; Tc—contribution time to retirement; t—contribution rate (0.3); Le—remaining life expectancy at retirement; and Age—age at the time of retirement.

The objective of this discount factor was to provide disincentives for early retirement and generate savings on pension benefits by offering higher pensions to new entrants with a longer contribution history and shorter residual life expectancy at retirement. Following a transition period in the 2000s, the discount factor contributed to lengthening of the contribution periods and increasing retirement age from 2009 on. It also generated lower pension benefits by about a third of what would have been paid out in the absence of this mechanism (Pereira, 2013).

In mid-2015, a new rule was introduced which would allow workers to retire with full benefits when the sum of age and contribution years was equal to 85/95, with a minimum of contribution of 30/35 years for women/men.2 The use of fator became optional but workers who decided to retire with 30/35 years of contribution regardless of age would have their benefits curtailed by the application of the fator. These changes in rules were expected to postpone retirement but also to increase benefits in the period during which pensions were enjoyed, thus pushing up pension spending over the medium term.

Nine months into the implementation of the 85/95 rule, there have been rapidly increasing retirement applications and widening spread between pension benefits based on length of contribution (mainly those of higher-income workers) and benefits based on age (those of informal and precarious workers with shorter contribution histories). However, early assessment of the effect of this change in the retirement incentives is affected by a strike of INSS employees in the second half of 2015, which contributed to a backlog of retirement applications, and possibly also by the start of public discussions about the needed reforms in the pension system—including the introduction of the minimum retirement age—which could have contributed to some advancement of retirement decisions.

1 The minimum and maximum monthly earnings for benefit calculation purposes are the same as in retirement based on length of contribution. (OECD, 2015)2 This formula is to be adjusted every two years until it reaches 90/100 in 2026.

11. When benchmarked against other countries, the generosity of Brazil’s pension system is evident. Total pension expenditure (public and private) is higher than in the advanced- and emerging-economy average, both as a share of GDP and per pensioner. When accounting for the demographic structure of the country, estimated spending on pensions in Brazil in 2015 was among the highest in a sample of about 100 countries (Figure 2 and Table 2).6

12. Gross and net replacement rates are above the OECD average, for male as well as for female pensioners (at 70 and 76 percent of average wage for men respectively).7 Pension contribution rates are extremely high and exacerbated by additional payroll levies, and contribute to high informality levels (contributors represent only 46 percent of working age population compared with 86 percent in advanced economies). Pension coverage, expressed as the share of pensioners to population aged 65 and older, is high at 93 percent, and close to advanced economies average, reflecting low effective retirement age for men and women and non-contributory pensions. The minimum retirement age with full contributory history in the mandatory public regime is 48 for women and 53 for men and the average retirement age in the RGPS is 58 for the “age” pensions and 55 for the “contributory” pensions against 64 for the OECD countries. The internal rate return, the difference between what an average retiree obtains (a person who enters the labor market at 25 years and retires at 65) from the pension system and what it contributes while working, is also high in international perspective.

uA03fig01

Internal Rate of Return, by Average Wage, 2015

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: OECD; and IMF estimates

13. The RGPS has been running deficits, mainly driven by rural pensions. Revenues of the RPGS pension system increased from 4.7 percent of GDP in 2003 to 6.1 percent in 2014. During the same period, expenditures increased from 6.2 to 7.5 percent of GDP as the number of pension recipients increased by 40 percent (Caetano, 2015). However, “urban” pension balances have been in positive territory in recent years and overall deficits were driven by limited contributions in the rural areas. In 2015, reflecting declining revenues due to the rising unemployment, the overall deficit in the RGPS reached 1.5 percent of GDP.8 Growing deficits in the pension system require growing subsidies by the Treasury to finance the gap. According to authorities’ projections, this imbalance will amount to 3.2 percent of GDP in 2016 (Tesouro Nacional, 2015).

uA03fig02

RGPS Financial Results

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: MPS; and IMF Staff estimates.

The Health System

14. Brazil’s Unified Health System (SUS) was established by the 1988 Constitution with the objective of providing universal health care in an equitable way and with continuity. The subsequent reforms revolutionized the health system by expanding hospital capacity, as well as enhancing primary care offered through outpatient structures. Moreover, the funding framework was also unified and health spending was financed through general revenues, social contributions and, for some time, the Contribuição Provisória sobre Movimentações Financeiras (CPMF).9 Service provision was decentralized to municipalities, and physical access was equalized across regions. However, administration of such a complex, decentralized public-health system, in which a large share of services is contracted out to the private sector, together with many private insurance providers, has caused conflicts and coordination issues.

15. Over time, the financing mix has evolved. While states and municipalities must dedicate 15 and 12 percent of their budgets respectively to health since 2000, federal government contributes 6–7 percent of its gross revenue, and finances half of the total public spending on health. The share has, however, declined significantly reflecting decentralization of health provision over the past two decades. Financing of private provision shifted from more expensive fee-for-service arrangements to prospective payment mechanisms and results-based mechanisms for transfers from the federal government to municipalities.

16. Public spending on health increased in Brazil since the mid-nineties and is set to rise further in the near future. Since 1995, real growth of public outlays on health was 5 percent on average (against 4 percent in LAC) and reached 4.6 percent of GDP in 2013 (from 2.9 percent of GDP). Public health spending remained constant as a share of total government expenditure, and below that of LACs and OECD countries whose share in total reaches 30 percent (Figure 3). In 2012, a complementary law established that federal government spending on health should grow at least in line with previous year’s nominal GDP. A constitutional amendment approved in 2015 set the minimum spending on health to at least 13.2 percent of net current revenues. This ratio is to increase until it reaches the 15 percent of net current revenue in 2019.10 Tax expenditures, arising from the uncapped deductibility of health expenditures from personal and corporate taxes, was estimated at R$31.5 billion in 2015 (Receita Federal, 2016). Tax incentives have also stimulated acquisition of private health insurance plans whose incidence grew from 18 to 26 percent of population since 2000. (OECD, 2015b)

Figure 3.
Figure 3.

Health Expenditure, 2013

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: World Bank.1/ The dashline is the average for Central America.

17. Private spending on health continued growing in parallel. One of the beliefs underlying the SUS reforms was that the role of private health care would decrease as a result of increased government spending and expansion of services. Contrary to expectations, private health care coverage continued to grow in real terms, but stabilized as a share of total health spending in recent years. The share of out-of-pocket expenditure constitutes over 30 percent of total expenditure, significantly higher than in OECD countries although in line with the LACs average (Figure 3).11 At about 5 percent of GDP in 2013, private spending on health is almost proportional to government spending on health in Brazil, and represents a greater share of total spending compared to the average share in LACs.12 Reflecting relatively high spending on private programs, total health expenditure in Brazil, at 9.7 percent of GDP, was above the LAC average, and more in line with the average share of spending in GDP in OECD countries.

18. Health outcomes of Brazilians have improved markedly over the past two and a half decades, contributing to higher life expectancy and lower child mortality. Brazil has near universal coverage of immunization and pre-natal care, as well as hospital deliveries. Studies have shown that mortality from avoidable diseases has declined over time thanks to improved health service delivery. Geographical disparities in health interventions of this type are limited (Gragnolati et al., 2013). Infant and under-five mortality rates have decreased to 20 and 23 per 1,000 births respectively, and maternal mortality is in line with upper middle-income country average. Life expectancy has improved overall, and has equalized across states over time, also reflecting increased income and control of tobacco use.

19. Brazil’s healthcare system faces challenges common to developed countries. In emerging economies, life expectancy is lower and infant mortality higher than in advanced countries. At the same time, basic health coverage of the population tends to be lower and health outcomes are generally worse. The main objective tends to be expanding basic coverage and improving outcomes. In contrast, basic coverage in Brazil is universal and the pattern of diseases affecting the population in Brazil increasingly resembles problems of mature economies. Worsening demographic trends are rapidly complicating health spending sustainability. Specific healthcare challenges in Brazil are the following:

  • Progress is still needed to improve the health status of large population segments and reduce regional disparities. To address these challenges, the government has introduced a program in 2013 (Mais Médicos) to hire doctors to work in poor areas plagued with medical staffing shortages.

  • Old health problems are lingering while new ones are manifesting as a result of urbanization and social and environmental change. For instance, diabetes prevalence in population ages 20 to 79 is at 8.7 percent in 2014 were closer to the advance (OECD) economies average, above that of middle-income countries and LAC.13 Meanwhile, some old health issues persist, such as malaria and dengue fever.

  • Dissatisfaction with the quality of service provision is high while per capita real funding for health care may be reduced in line with government efforts to combat the fiscal crisis.

C. Challenges from Ageing Population

Demographic outlook

20. Brazil has one of the fastest aging populations in the world.14 A continued but gradual decline in fertility rates is projected to take place in less developed countries, including in Brazil (Figure 4). Because these estimates are surrounded by considerable uncertainty, the UN illustrates two scenarios: the “medium fertility” projection assumes a continuous decline to about 2 children per woman by 2100 from 2.6 in 2015, while the “low fertility” scenario implies an immediate drop by about 0.5 children per women.

Figure 4.
Figure 4.

Projected Fertility Rates

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: UN; and IMF staff estimates.

21. The decreasing trend in fertility rates is coupled with increasing longevity. Whereas longevity improvement is expected to slow down in the more developed economies, for the less developed economies and Brazil the projections suggest continued improvements in longevity, as under-5 as well as old age mortality decrease reflecting increasing health care coverage (Figure 5). As the share of youth and working age population declines, old-age (above 65) population is expected to reach 40 percent as a share of people ages 15 to 64 by 2100 in Brazil.

Figure 5.
Figure 5.

Projected Mortality Rates

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: UN; and IMF staff estimates.
Fiscal impact

22. Population ageing has been an important driver of pensions spending in Brazil, along with other determinants. The growth in pension expenditure as a share of GDP can be decomposed into four distinct contributions: the growth of average replacement rates, the increase in benefit coverage, the impact of demographic changes on the old-age dependency ratio, and the change of the inverse of employment rate. In Figure 6, the worsening age profile in Brazil and increasing replacement rates have affected pension expenditure growth over the past one and a half decade strongly. Higher replacement rates were the main driver of increasing pension spending in other emerging economies since the 1990s, but declining labor force and population aging have also played a role in emerging Europe (Clements et al., 2013). The fator previdenciário (fator), in effect since 1999, may have helped reduce the ratio of pensioners to the elderly population (i.e. the “benefit coverage”, see Box 1).

Figure 6.
Figure 6.

Decomposition of Pension Expenditure

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: WDI, UN, OECD, INPS; and IMF staff estimates.

23. Health care expenditure also grows with the old-age dependency ratio albeit at a slower pace. On the demand side, the literature has identified raising income and aging population as the main drivers of public spending on health in advanced economies. Because elderly people consume more health care services than young people, increases in the share of elderly population increase health spending as a share of GDP. Other, non-demographic factors including technological change, and the lower productivity of services relative to other sectors (the so-called Baumol effect) account for the remaining share.

Table 3.

Determinants of Health Care Spending

article image
Robust standard errors in parentheses*** p<0.01, ** p<0.05, * p<0.1

24. Reflecting rapidly ageing population, Brazil’s spending on pension and health is projected to reach unsustainable levels already in the next decade. In an inertial baseline projection without reforms, pension spending rises to almost 14 percent of GDP by 2021 (Figure 7), 17 percent of GDP by 2030, and 29 percent of GDP by 2050. This projection reflects the decline in real GDP over 2015–16, the rise in the real value of the minimum wage (affecting some 70 percent of pensioners), and uses the Treasury’s projections of growth in the population of retirees, which is subject to larger-than-usual uncertainty because the new 85/95 rule introduced in mid-2015. 15 We also calculate a more optimistic forecast with average pensions growing with average wages (an underestimate by construction); the result is only slightly less worrisome (green line), and still well above official actuarial projections. Official projections (blue line) show very slow growth in pension spending over the next several years, which would be possible only if benefits are reduced significantly or if benefit coverage declines.

Figure 7.
Figure 7.

Pension Expenditure Projections, 2015–21

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: RGPS and RPPS actuarial reports; and IMF staff estimates.

Realism of Baseline Pension Expenditure Projections

A few characteristics of the Brazilian demographic profile and pension system are not fully captured in our baseline projections. We are projecting pension expenditures for the overall private and public systems aggregate. The growth in benefits is slightly overestimated because in the RPPS system virtually all pensions are above the minimum wage and are therefore adjusted upward in line with inflation—not in line with the growth of the minimum wage. On the other hand, however, civil servants retire earlier, particularly in the states where employment is disproportionally more concentrated in education and security services.

Another force not factored into our projections that may push expenditures up compared to the baseline is the higher participation of women in the labor force. Except for the very recent period, which witnessed a generalized decline in labor participation, female labor force participation has increased to over 60 percent of working age population in 2014 from 45 percent in the 1990. The share of female retirees in total has also increased to 56 percent (Informe de Previdência Social, 2014). Reflecting the current retirement rules which allow women to retire earlier, and given higher female longevity, pension expenditure can be expected to grow faster than under the baseline. Finally, our projections do not include possible effects of past reforms whose influence on spending may be delayed.

25. The pension and health spending long term trends are substantially worse in Brazil than in advanced and in other less developed economies.16 Under unchanged policies (the “no reform” scenario), spending on pensions alone would reach 21.5 percent of GDP by 2050 in Brazil. Public spending on health would increase to 5.6 percent of GDP in 2025 (9.5 percent of GDP by 2050) from 4.6 percent of GDP in 2015 (Figure 8). The NPV of the funding gap of the social security system was estimated at 25 percent of GDP over the following two decades (IMF, 2012). However, since then, Brazil’s potential growth was revised downward. This affects revenues adversely and contributes to an even larger funding gap.

Figure 8.
Figure 8.

Pension and Health Spending Under the Baseline Scenario

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: IMF Staff estimates.

26. A sensitivity analysis is applied to study the effect of different aging scenarios on long-term pension and health spending and the effect of reforms. Health care spending is expressed as a product of the generosity of spending on young population, the inverse of the labor force participation rate for the young, and a function that depends on the old-age dependency ratio and the ratio of per capita health spending on old to the per capita health spending on the young.

HEGDP=HE0−64pop0−64GDPwor⁢ker⁡spop0=64wor⁢ker⁡s(1+αpop65+pop0−64,whereα=HE65pop65+HE0−64pop0−64)(2)

Holding everything else constant in (1) and (2), an increase in the share of population aged 65 and above translates in an increase in pension and health spending to GDP. In the short run, effects of different assumptions on growth should be small reflecting the fact that current pensions are determined by past growth/wage realizations. However, pension spending can diverge from the model outcome if pensions are indexed to minimum wage growth and minimum wages grow above productivity, as is the case in the “no reform” scenario in Brazil.17

27. The impact of lower fertility and higher longevity on spending on age-related programs could be significant. Compared to the baseline presented above, we also estimate two risk scenarios, to take into account potential shocks on fertility and longevity assumptions. For example, spending on pensions and health in Brazil would increase by 3 percentage points of GDP by 2050 (25 p.p. by 2100) under the “low fertility” scenario. Under the “longevity risk” scenario, assuming that mortality rates for age 65 and older decline 50 percent faster than in baseline, pension and health spending would be 1.6 p.p. of GDP higher by 2050 (4.8 p.p. higher by 2100).

D. Reform Options

28. Policies available to address fiscal pressures from pensions and health belong to two broad groups: policies affecting labor force participation, and policies directly affecting features of these spending programs. Broadly speaking, policies directed at pension and health programs aim at increasing financing of these programs and/or lowering generosity of benefits.

Labor market reforms

29. Policies that increase labor market participation for women and the elderly can partially offset the impact of aging. As in other Latin American developing countries, female labor market participation in Brazil is substantially lower than male participation by 20 percentage points, (65 as opposed to 85 percent of population age 15–64 in 2014). Absent a decline in average productivity per worker, halving the gap would boost GDP and increase financing for age-related spending, so that the ratio of such spending would fall by 2.2 percentage points of GDP by 2050. Brazil has low labor participation rates for population between 55 and 64 years old (56 percent in 2014 compared to the 81 percent for the age group between 25 and 54 years old).18 While this gap is common in other Latin American countries, halving it would contribute to save 1.3 percentage points of GDP by 2050 (Figure 9).

Figure 9.
Figure 9.

Labor Market Policies

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: IMF Staff estimates.

Pension system reforms

30. While countries may opt for a variety of policies to reform their pension systems, generally efforts aim at containing eligibility, lowering replacement rates and increasing revenues. The combination of policies will depend on the country’s objectives and reflect different social, political and economic preferences.

  • Containing eligibility: raising retirement ages is an especially attractive option and helps complement efforts to boost the labor force participation of older workers.

  • Increasing revenues: increasing taxes on pensions for upper income groups and/or increasing payroll contributions.

  • Reducing replacement rates: the ratio of pensions to wages can be reduced by abandoning indexation to the minimum wage for instance, lengthening the period over which the pensionable wage is estimated, and/or modifying benefit formulas (accrual rates).

31. Brazil faces several policy alternatives to stabilize, and eventually reduce, pension deficits. With a deficit in the pension system equivalent to 1.5 percent of GDP in 2015 (and projected to reach 4.2 percent in 2025 in the authorities’ scenario)19, the minimum objective of any pension reform should be to stabilize the financing gap. By introducing reforms that prevent pension imbalances from growing, authorities can stabilize the amount of the subsidy that needs to be transferred every year from the federal budget to the social security system. This would be a major step forward in addressing fiscal sustainability problems in Brazil.20

32. Options to contain spending include some combinations of the three main policy instruments mentioned above (i.e. raising retirement age, increasing contributions and/or managing the generosity of benefits). These trade-offs are summarized in Figure 11. In Brazil’s case, pension contributions are already high and need to be reduced over time to reduce market disincentives. To stabilize pension spending over 2015–30 it would be necessary, for instance, to reduce benefits by almost 35 percent or increase the retirement age by almost 6 years. A combination of options along the along the green line in Figure 10 would achieve the same result.21

Figure 10.
Figure 10.

Reform Options to Stabilize Pension Spending, 2015–30

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: IMF Staff estimates.

33. Gradually raising retirement ages is an attractive policy option for Brazil, but it is only a starting point. Increasing retirement age would also boost labor participation and growth, and avoid the need for larger cuts in benefits. It would also be desirable as retirement age in Brazil is comparatively low. Increasing the retirement age by 5 years over the next 5 years would generate savings in pension spending equivalent to 4.7 percentage points of GDP by 2030 compared to the “no reform” baseline. However, this overestimates the true contribution of the retirement age increase to savings inasmuch as the model assumes that pension payments remain unchanged (i.e. the replacement rate at retirement is constant), which is not the case when contributory history is longer. In the model, pension spending would be above the level in 2015 by about 1 percentage points of GDP (Figure 11).

34. Another source of pressure is the growth in the real benefits to existing pensioners. To solve this, it is necessary to remove the automatic link between pensions and the minimum wage (and/or to change the minimum wage formula). This would reduce pension expenditure by about 2.6 percentage point in 2030 (6.1 percentage points of GDP in 2050). But to frontload the rescue of the pension system by removing existing payroll tax exemptions would be advisable. A temporary freeze of nominal benefits (18 months, for instance, equivalent to a 10 percent cut in benefits) of existing pensioners could be considered as well, or at least a significant deceleration in their growth. An ambitious package would even create space for gradually lowering the currently high payroll contributions, with an overall neutral effect on spending over the long run. After 2050, the system would stabilize by linking the increase in the retirement age to gains in life expectancy.

Figure 11.
Figure 11.

Estimated Impact of Various Pension Reform Options

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: IMF staff estimates.

Health system reforms

35. More limited funding does not need to jeopardize access to services or affect health outcomes given existing inefficiencies in the utilization of resources. Health-adjusted life expectancy of 65 years for Brazil is associated on average with higher public spending on health, both as a share of GDP and in per capita terms than elsewhere (Figure 3), suggesting there may be opportunities for achieving the same or higher outcomes while employing fewer resources, by aligning capacities to needs and reducing waste. Evidence of oversupply of technology in certain areas and underutilization of medical infrastructure, possibly resulting from attempts to equalize access to services across the country, have been documented in the literature (La Forgia and Couttolenc, 2008) and it is known that adoption of new technologies has not been subject to opportunity cost scrutiny so far.

Figure 12.
Figure 12.

Impact of Health Reforms

Citation: IMF Staff Country Reports 2016, 349; 10.5089/9781475553222.002.A003

Sources: IMF staff estimates.

36. Going forward, options for cost-containment for Brazil can draw from the vast experience of advanced economies over the past few decades. A number of micro level reforms can improve health outcomes without increasing spending. Health technology assessment could support selection of new health care programs, drugs, and diagnostic equipment and tests. Moreover, focus will shift to avoiding and curing chronic non-communicable diseases that become prevalent as population ages, and efforts will have to include education programs that induce healthy life style and prevention (Schmidt et al., 2011). Savings could be achieved in the future by abolishing tax-deductibility of private insurance contributions which have undermined funding for the SUS and on which patients still rely for expensive treatments not covered by private plans. Other areas for action could include: elaboration of clinical guidelines, reducing dependency on imported technologies, and renegotiating deals with pharmaceutical companies. Linking of health expenditure to government revenue and backward-looking line-item budgeting could be replaced with global budgets and activity-based payment mechanisms that improve transparency and efficiency. However, the financial impact of these reforms is difficult to quantify.

E. Concluding Comments

37. Brazil’s population is aging rapidly and fiscal pressures are set to rise over time absent reforms to benefits. The demographic profile of the country and the already generous benefits system will put the finances under considerable strain over the next decades. As the dependency ratio climbs up, spending on pensions and health could surpass 31 percent of GDP by 2050, everything else held constant. Although labor market reforms can provide some temporary respite, reforms directly addressing high replacement rates cannot be avoided.

38. The growth of the publicly provided health care system will be difficult to sustain. Health care reform will have to contain growth of budgets without adversely effecting health outcomes by ensuring marginal expenditure is closely linked to incremental health benefits. While this is easier said than done, experience of advanced economies in health care cost containment offers important lessons for Brazil. The recently approved health expenditure rule which sets a floor on public spending on healthcare does little to ensure efficient utilization of resources. More remains to be done to reduce reliance on more expensive hospital treatments, by strengthening outpatient care and regional networks, and to reduce spending on pharmaceuticals, by promoting use of generic drug and developing clinical guidelines for the choice of cost-effective drugs and treatments. (OECD, 2015b)

39. Pensions reform options include some ideas already under discussion it the Brazil’s government. Raising retirement age is currently debated in public and included in the government’s agenda, while other needed reforms have been understood for a long time in Brazil. Although the deteriorating demographic profile will not affect public finances in the short-run, other features of the system, notably the link of pensions to the minimum wage and the latter’s indexation rule, are driving pension spending up. To galvanize political support and foster social acceptance reforms should be equitable and mindful of the poor, but also gradual. To be gradual, reforms should start now.

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1

Prepared by Izabela Karpowicz and Carlos Mulas-Granados with support from Mauricio Soto and Kamil Dybczak.

2

2013 estimate.

3

COFINS and CSLL are social security revenues. There are numerous exceptions to standard contribution rates which lower the effective rates.

4

Contributions to pension plans are tax-deductible, up to certain limits, for both the employee and the employer. Pension benefits are taxed as ordinary income.

5

The percentage varies depending on the public entity.

6

In Brazil, some of the pension system benefits have social assistance features which complicates the cross-country comparisons. Social benefits in other countries may be included in different expense category.

7

The gross replacement rate is defined as gross pension entitlement divided by gross pre-retirement earnings. The net replacement rate is defined as the individual net pension entitlement divided by net pre-retirement earnings, taking into account personal income taxes and social security contributions paid by workers and pensioners. These indicators are measured in percentage of pre-retirement earnings by gender.

8

A similar deficit was recorded in 2015 in the RPPS, where the number of beneficiaries is substantially lower, as contribution rates are extremely low.

9

The federal health fund contributes to state and municipal funds which are also finances by subnational revenues (Couttolenc and Dmytraczenko, 2013).

10

A recent proposal to increase the share to 14.8 percent in 2017, followed by increases to 15.5, 16.2, 16.9, 17.6, 18.3, and 19.4 percent in 2023, is under discussion in the Senate.

11

Out of pocket expenditure is any direct outlay by households, including gratuities and in-kind payments, to health practitioners and suppliers of pharmaceuticals, therapeutic appliances, and other goods and services whose primary intent is to contribute to the restoration or enhancement of the health status of individuals or population groups. Private health expenditure includes direct household (out-of-pocket) spending, private insurance, charitable donations, and direct service payments by private corporations.

12

According to surveys, Brazilians rely on private provision for dental services.

13

Other non-communicable diseases, such as cardiovascular diseases, hypertension, obesity, and neuropsychiatric disorders account for the overwhelming majority of causes of death and their trend is worrisome. (Victoria et al., 2011 and Schmidt et al, 2011).

14

Based on demographic projections by UN (2015 Revision of the UN World Population Prospects). The assumptions behind the projections of fertility and mortality rates, and migration are described in Clements et al (2015). In Figures 4 and 5, “more developed economies” are Australia, Canada, European countries Japan, New Zealand, and the United States, while “less developed countries” include the rest of the world.

15

The Brazilian statistical institute (IBGE) projects that old-age dependency will reach 36 percent by 2050 from 11 percent today. The population of retirees is growing at about 3.6 percent a year. Given the rule for updating the minimum wage and its link to pension benefits, most retirees’ benefits grow about as fast as nominal GDP; thus, the nominal growth in contribution revenue is barely enough to pay for the annual rise in the benefits of existing pensioners: little money is left over to finance the increase in the number of retirees.

16

The demographic estimation uses baseline population projections by the UN under the “medium variant” scenario which employs probabilistic models to extract projectors of fertility and mortality rates for individual countries. Beyond 2065, pensions are projected to grow in line with demographic developments.

17

Second order interactions are not taken into account in the model.

18

ILO; based on Pesquisa Mensal de Emprego.

19

Tesouro Nacional, 2015; includes RGPS and RPPS of the federal government.

20

Under the proposed constitutional amendment, capping nominal expenditures to GDP over the next 20 years, the objective is even tougher as it implies that federal social security spending must fit under the cap.

21

There is a 6.5 percentage point increase in spending increase on pensions between 2015 and 2030 (from 12.2 to 18.7 percent of GDP). An across the board reduction in benefits of 35 percent (6.5/18.7), would bring spending down to 12.2 percent of GDP in 2030. To achieve the same result, retirement age would have to be increased by about 6 years: we estimate that in 2013, about 28 percent of the population age 60+ is aged 60–64. This means that an increase in the retirement age by 5 years would cut beneficiaries by about 28 percent. To achieve a 35 percent cut, pensionable age would have to increase by 5.7 instead of by 5 years. The third option is increasing revenue from contributions. We assume that in Brazil it is possible to raise about 0.4 percent of GDP per each contribution point (this is based on the wage-to-GDP ratio and might be optimistic). To achieve 6.5 percent of GDP in savings, it would be necessary to raise pension contributions by 16.2 (6.5/0.4) percentage points.

Same Series

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Other Publishers

Cover IMF Staff Country Reports
Brazil: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2016: Issue 349
Publisher:
International Monetary Fund
ISBN:
9781475553222
ISSN:
1934-7685
Pages:
159
DOI:
https://doi.org/10.5089/9781475553222.002

Demographic Indicators, 1960–2014

RGPS Benefits, 2015

(Percent of total value)

Pension Expenditure and Share of Elderly

Internal Rate of Return, by Average Wage, 2015

RGPS Financial Results

(Percent of GDP)

Health Expenditure, 2013

Projected Fertility Rates

Projected Mortality Rates

Decomposition of Pension Expenditure

Pension Expenditure Projections, 2015–21

(Percent of GDP)

Pension and Health Spending Under the Baseline Scenario

(Percent of GDP)

Labor Market Policies

Reform Options to Stabilize Pension Spending, 2015–30

Estimated Impact of Various Pension Reform Options

(Percent of GDP)

Impact of Health Reforms