From: Foundation for Economic Growth
Ageing and Ailing Societies: Health and Social Security Reform
By Matus Petrik
Oct 31, 2005, 12:19
It is almost unbelievable that, only fifteen years after the fall of communism, we are able to discuss topics such as the East’s positive influence on the West. I am not quite sure whether this is more a result of the sorry state of public affairs in Western Europe, or the supposedly splendid achievements of the free market reforms in Eastern Europe that are currently under way. I am afraid it is more the case of the former than the latter.
As much as I welcome the incentives such discussions bring to western European public life, and the pressure they help to create on Western European politicians, coming from Eastern Europe I am naturally more concerned about the sense of complacency that is spreading around the region.
I hate to spoil the party, but my understanding and perception of Slovakia’s reforms is a lot bleaker than those of my coauthors. A case in point would be the much-celebrated flat tax reform. Everybody boasts about the decrease in corporate income tax, the elimination of progressive income taxation and the creation of a 19% flat rate income tax, but the other side of the coin is that actually the biggest tenet of the whole reform was not the decrease in taxes but its fiscal neutrality.
Tax reforms do not necessarily mean a decrease in tax revenues. In fact the opposite can be true. The decrease in tax revenues stemming from the reduction in income tax is more than offset by the increase in Value Added Tax, consumption taxes and the like. Elimination of tax exemptions effectively means that people have less money in their pockets, to spend in accordance with their wishes and in pursuit of their needs. So I would not quite call it a liberal tax reform, even though some aspects of it are definitely positive.
Moving to the other reforms, such as the pension reforms that are just being introduced in Slovakia, we all can acknowledge that the previous pay-as-you-go system was, as in any other country, a mess. This was especially the case because benefits were calculated on a nonsensical basis, taking into consideration only the last ten years of a person’s income; out of those ten years, the five highest-earning years were then used as the basis for the calculation of pension entitlements. This was clearly absurd, and led people to hide their incomes prior to this relevant time period, and then to inflate them at the end, so as to hitch a free ride on the scheme.
As part of the reform of the pay-as-you-go system, this absurdity was eliminated and a more contribution-based system introduced, taking into consideration all previous earnings. The ceilings on pension entitlements were removed, or raised - in my view the next-best solution after the total abolition of the pay-as-you-go system.
The current system is similar to a three-pillar system, but it is too early to assess its impact on future pension entitlements since the process has only just started. But there are several aspects of the reform that remain unresolved and may become a potential liability in the future. One such problem is that there is no clear idea of how the shortfall in financing the pay-as-you-go entitlements, which actually increased as a result of the reform, will be overcome. A lot of the funds will be directed as contributions to the capitalisation pillar, and it is known that the government’s plans for making these up can last for only ten years. These funds are coming from privatisation revenues, which are one-time revenues.
We do not know how the rest will be financed – whether by increasing taxes, increasing state debt or via an increase in pension contributions. All these alternatives will have radically different impacts on the outcome of the reform – and on the actual impact of the reform on the population. We cannot even say who the winners and losers will be in the long run.
Another problem associated with the capitalisation pillar is that it does not really address the problem it is supposed to tackle - the adverse effects of demography, and in particular the ageing population. Even the revenues from the capitalisation pillar will be financed from the sale of securities or stocks, which will have to be bought by the productive sector of the population. But these people form a shrinking pool, which will bring down prices and hence potential revenues from the capitalisation pillar.
The introduction of the capitalisation pillar is also quite an expensive enterprise. Hitherto pension fund companies’ fee rates have been set at an artificially low rate, and these will eventually have to be increased, because the present system is unsustainable. This will also bring potential liabilities and decreases in the revenues of the capitalisation pillar.
There are also very strict rules concerning investment for the pension fund companies, because of recent defaulting experiences. These will decrease the actual investment yields for these companies. For example, pension funds must invest at least 30% of their revenues in Slovakian stocks and securities, an incredibly high amount given the very small size of the Slovak stock market.
The concept of benchmarking has been introduced, leading to minimum requirements for investment yields as measured by the average investment yields of other companies in the business. If these are not met the shortfall has to be made up out of the companies’ own funds. This eliminates competition because companies working under these strict rules cannot distinguish themselves in the potential competition for customers.
Again, it is too early to assess the potential success of the pension reform, but as it is conceived now, and as it stands in law, it will still have to deal with a lot of unresolved issues and potential problems in the future.
From a liberal point of view, there remains a further, basic problem: the impossibility of opting out of the system. You have to take part in the mandatory savings scheme, which contradicts the wider rhetoric about bringing more freedom and responsibility for their own destiny to the people of Slovakia.
A better case for free market reforms in Slovakia is the case of the recently introduced healthcare reform. The acts were passed in the autumn of 2004 and the reforms are under way right now.
The previous healthcare system in Slovakia was a sorry state of affairs. Costs were rising annually by half a per cent of GDP, which is a very high figure, resulting in mounting debt and a vicious circle of inefficiency and no incentives. The very first step that the government undertook upon entering office was to introduce obligatory payments for each visit to the doctor and for the issuance of drug prescriptions. The payments were only 50 cents, which is minimal, even by Slovak standards. But they contributed to the notable result of helping to balance costs and revenues in running the healthcare system.
The biggest fight over healthcare reform in Slovakia was over the issue of direct payments for the provision of health-care services. In Slovakia there is a constitutional requirement that healthcare be free, based on the public health insurance scheme. So the constitutional court got around the issue by declaring that the payment was actually payment for services related to the provision of healthcare services. I have to warn my Czech friends that the most emotional debate among politicians centred around slogans such as ‘Is health for sale? Is it not too important to be left to the free market?’
I would say that, subsequent to reform, the supply side of the healthcare system is in much better shape than the demand side. As a result of the reforms a form of partnership running both healthcare provision services and health insurance was introduced. It could be adapted so that companies would be able to make a profit, even though there are problems associated with this. For example, health insurance companies were not allowed to buy stakes in or enter the business of provision of healthcare services, which, if permitted, would bring about greater efficiency. But the market will find a way to make this happen indirectly.
The problem is more on the demand side. The scope of healthcare services to be provided under the public health insurance scheme is prescribed by law - there is a list of all the diseases that will be covered by the scheme, regardless of the contributions made to the system by the insured persons, their risk classification, and so on. So I suspect that the Slovak system will retain the problem of moral hazard, which reform was supposed to remove. Financial sustainability of the whole system will not be achieved, but at least it has embarked on a humble step in the right direction.
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