Russian Economic Reform

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Russian pension reform – a long road!

Published on October 08 2012
Posted by: jeff

I have up until now avoided writing much about Russian pension reform (mainly because of the very long-term nature of the calculations, which means that it is generally not a very exciting issue as well as having a high degree of uncertainty), but both recent events in Russia and a useful recent IMF Working Paper entitled “Reforming the Public Pension System in the Russian Federation” mean that it is time to tackle the issue in more depth – at least in terms of giving an overview of the situation.

A little over a week ago Dmitry Medvedev signed-off on a plan for pension reform which was then sent to the Kremlin (Putin had earlier criticized the fact that the three year budget outlook for 2013-5 did not include a significant pension reform plan). Medvedev’s plan was almost immediately called into question by a number of other official and non-official players.

One Kremlin official even suggested that the Medvedev approved plan may actually end up being termed only a “report to the president”: «С учетом нашей реакции будут решать этот формально-процедурный вопрос» Alexei Kudrin, the former finance minister, seems to have become a player on this issue, and has lined up against Medvedev. Kudrin is suggesting that no final decision will actually be made before January 2013 and only after “more serious calculations” (he says he intends to submit his own version of pension reform for consideration). 

The Medvedev plan is reportedly favored by the Ministry of Labor and the Pension Fund of Russia (RPF), but opposed by the Ministries of Finance and Economic Development.

The following table is a good place to start with the pension story as it now stands. (I have left out, for convenience, several factors including that relating to people born before 1967).

In 2012 and 2013, employers must make a contribution (this payment is sometimes called a payroll tax) equal to 22% of annual individual wages up to a wage limit of 512,000 rubles to finance pension payments. Once the 512,000 wage limit is exceeded, the contribution becomes 22% of 512,000 rubles plus 10% of the wage about this amount. Prior to 2012 the contribution rate was 26% rather than 22% (with the “united” part under the “insurance” category equal to 10% rather than 6%) — and it is due to revert to 26% in 2014.

Annual wage base for payment of contributions “Insurance” for people born 1967 and later “Accumulation” for people born 1967 and later
Up to 512,000 rubles 16%, of which:6% “united” part;

10% “individual” part

6% “individual” part
Above 512,000 rubles 10% “united” part 0

 

I have written about aspects of this issue before. (See “Expert Group 3: Reform of the Pension System” and see “Expert Group 6: Taxation Policy” in right-hand column).

The reform plan sent by Medvedev to Putin can, reportedly, be divided into three stages which begin in 2013 and end in 2030. The first stage is to be implemented in 2013-15 and includes reduction of the 6% accumulation part by at least 4 percentage points (and possibly by all 6% depending on the choice of individual contributors) to 2%, with the contribution payments instead being sent to the “united” part within the “insurance” category. That is, in the table, the 6% “united” part (under the “insurance” heading) would become 10% in 2013, and the “individual” part (under the “accumulation” heading) would fall to 2%. In the second stage, to be implemented in 2016-20, incentives will be given for the accumulation contributions to be increased on a voluntary basis from the 2%. Thereafter, until 2030, efforts will be made to stimulate corporate pension schemes.

Once reform is complete, according to the Medvedev plan, a worker who made contributions for 40 years at the average wage will receive a pension equal to 40% of that wage. Moreover, the annual Russian state pension fund deficit (which must be financed from the annual Russian budget) will be reduced from 2% of GDP to 0.8%. (According to some earlier estimates  reported by ”Expert Group 3: Reform of the Pension System”, in the absence of reform transfers from the federal budget will need to increase by 1% percentage point of GDP every five years between 2010 and 2050.)

Alexei Kudrin says that the 16% “insurance” category is only “virtual” money (because it is actually only a paper transaction), but is accompanied by “real” obligations to pay pensions in the future. Kudrin is right in this, in so far as, according to an August 2012 IMF Working Pater (entitled ”Reforming the Public Pension System in the Russian Federation”), the “individual part” of the the insurance component is a “notional defined contribution pension” and is “pay-as-you-go”. “Contributions to individual accounts are not invested in financial assets, but are instead recorded in a notional individual account by the RPF. These accounts earn a notional return set by law.” In other words, the actual pension money paid now and in the future comes from present and future contributions and, because of the insufficiency of these, from the annual Russian budget.  

The reduction in the 6% “accumulation” category is controversial as many consider it a necessary source of funds for long-term investment in Russia.

Supporters of the Medvedev plan, however, point to calculations by the RPF that, because of the low yields on investments of accumulated contributions, pensions will be 24% lower in 2030 than if all the contributions went to the insurance category. Kudrin says he doubts these calculations, while the IMF says that these low yields have been partly due to restrictions on investments.

The IMF says that the 2012 contribution rate reduction from 26% to 22% reduced inflow to the pension system by around 0.5% of GDP. Total Russian spending on pensions and allowances add up to about 9% of GDP: about 30% of this spending is devoted to the basic pension (which is at least partially funded by the “united” contributions in the table above); 60% to the insurance component (presumably this refers to only the ”individual” part); and 10% to allowances.

According to the IMF, Russia is presently near international averages in terms of the “contribution rate” and “replacement rate” (average pension as a % of average wages). Moreover, at nearly 9 percent of GDP, “Russia looks similar to emerging Europe and advanced economies in terms of the current level of pension spending. Russia, however, devotes a relatively large share of its budget to finance public pensions. Pensions are about 23 percent of general government primary spending in Russia, just at about the emerging Europe average, compared to 20 percent in the advanced economies and only 13 percent in emerging economies outside of Europe. This might make Russian public finances more vulnerable to demographic pressures than in other countries.”

The IMF Working Paper says that there are three main dimensions along which pension reform to the “pay-as-you-go” aspect could be undertaken:

(1)   Reduce the “replacement rate”. According to the IMF, maintaining the current level of replacement rates (without other reforms) would increase public pension spending from 9 percent of GDP in 2010 to 12% in 2030 and 16% in 2050. Alternatively, keeping public pension spending at present levels would mean replacement rates would have to decline from about 40% presently to 28% in 2030 to 20% in 2050. The IMF says that “cuts of this magnitude are unlikely to take place and would be socially undesirable”;

(2)   Reduce the number of people receiving the pension. Russian men can presently access it aged 60 and women at age 55, According to the IMF, this contrasts with an average retirement age of 64 for men and 63 for women in the advanced economies and 61 for men and 58 for women in the emerging world. Furthermore, because of the many special concessions many individuals retire even earlier, so that the average effective retirement age in Russia is about 52–54 for women and 54–58 for men;

(3)   Increasing the contribution rates from the present 22% to about 30% in 2030 and to more than 40% in 2050. Such large contribution hikes could have adverse labor market effects and can further promote “informality” (ie wages paid by cash).

Of course, as the IMF notes, Russia could aim to improve the efficiency of payroll contributions collection. Indeed, in my view, this is – at least initially – where the emphasis should be.