The nature of work is being increasingly and suddenly altered by technological change, growing cross-border mobility, declining birth rates, and rising life expectancy. A growing share of work is done either under contracts that are shorter-term and less predictable, or without any contracts at all. Social insurance systems financed by payroll taxes created for times of stable employment with one formal employer and a substantial surplus of contributors over beneficiaries have become fiscally and socially unsustainable. Often, their rules leave the workers of the new economy without even a basic layer of social protection.
Big changes are needed to ensure public insurance schemes respond to the greater diversity of labor markets and forms of work. At the same time, policymakers need to still address the old challenges of providing adequate yet affordable support to workers and strengthening incentives for individuals to save more, invest continuously in their skills, and look for work. It won’t be easy to meet both these challenges at the same time, but that is what governments will have to do. Based on work being done at the World Bank, we emphasize three interconnected changes for social insurance to catch up with the diversifying world of work while addressing fiscal and social sustainability concerns:
- First, provide a basic layer of health and unemployment support, de-link social insurance from employment contracts, and change the financing of public schemes from payroll contributions to general government revenues.
- Second, for old-age pensions, move to a general-revenue financed basic pension for all and fold the remaining pay-as-you-go, (PAYGO) defined-benefit systems into a fully-funded, defined-contribution scheme for all who make contributions to the scheme, regardless of their employment status, and
- Third, set up a complementary pillar of privately-owned accounts for unemployment, health insurance, and old-age pensions, funded by tax-free private contributions.
Parts of these proposals have been implemented in advanced and emerging economies. The task now is to bring all three of them together to support workers, increase productivity, and ensure fiscal sustainability. This can be done in three steps.
1. Delink insurance from employment contracts and finance a basic layer of social insurance from general government revenues
The link between employment and public insurance through payroll tax financed benefits entails problems for governments, companies and employees. For governments, it is often difficult to properly define eligibility, ensure compliance, and reduce evasion. Add rapid aging to the mix, and the fiscal sustainability of social insurance schemes is seriously under threat. For both individuals and companies, the growing wedge between gross wages and take-home pay encourages informality, leaves people without social insurance, and dilutes the social contract. The solution is two-fold. The first is to eliminate the link between social insurance and employment status and provide a basic and affordable layer of social protection to all citizens, financed by general revenues. However, we are not recommending a universal basic income, which is likely to be too costly and politically challenging. The second is to supplement this insurance by a wider set of individually owned and financed insurance offerings.
2. Replace defined-benefit PAYGO pensions with a mix of a basic pension and fully funded pensions
Social insurance should encourage savings for old age while maintaining a mechanism for helping the most vulnerable parts of the population. Our proposal has two components. The first is a basic pension for all who reach a certain age, regardless of previous employment status, financed by general government revenues. This is especially needed in countries where few people participate in the contributory pillars. The second is a public defined-contribution scheme for anyone who chooses to make contributions, not based on wages and regardless of their employment status. There are several examples of such public programs. In 2008, Chile introduced a solidarity pension system funded by value-added tax revenues that covers all citizens older than 65. In the same year, the United Kingdom launched the National Employment Savings Trust (NEST), a defined contribution pension scheme. Unlike Chile’s solidarity pension, though, NEST is still limited to people who have formal employment contracts.
3. Diversify the mix of insurance offerings
To support these measures, the mix of social insurance instruments needs to be broadened to include private accounts for pensions, health, and unemployment. The mainstay would be tax incentives to save in accounts that can be created by anybody—regardless of employment status—that could include both a mandatory monthly minimum deposit and a voluntary additional contribution. Withdrawals can be made only for old-age pensions, health expenses, and unemployment support. Unused balances could be rolled over indefinitely and ultimately folded into the pension accounts. To be sure, private individual accounts already exist in many countries. But their reach is limited. For example:
- Voluntary fully-funded 401K pensions were introduced in the United States in 1978, but a small share of employees have such accounts and the amounts saved are modest: The median savings for families whose wage earners are 56-61 years old is $17,000.
- In Bulgaria, the balances in the voluntary third-pillar pension accounts created in 2000 now amount to just 1.25 percent of total accumulated pension rights.
- Participants in high deduction medical plans in the U.S. can create health savings accounts that allow for tax-free contributions with unlimited rollover. Balances amounted to just 0.3 percent of annual U.S. health spending at the end of 2016, however.
- Mandatory unemployment insurance savings accounts exist in most countries in Latin America; for example, Panama introduced them in 1972.
In summary, the march of machines is disrupting the existing social insurance schemes while raising fiscal sustainability concerns. A more diverse world of work requires a more diverse set of social insurance options. Governments have to ensure people have a basic coverage against health and unemployment risks. They have to use fiscal and behavioral incentives to encourage people to save more in individual accounts. Public insurance schemes will still be needed to pool risks more effectively so that workers are not left to deal with catastrophic losses on their own. But big changes are needed to make sure that they don’t bankrupt governments either, and leave taxpayers with burdens they can’t bear.