TCS Daily


Argentina's Pay-Go Stoppage

By Adam Paul - December 8, 2008 12:00 AM

In the United States, serious Social Security debate has accepted that promised benefits will soon outstrip revenues to pay them. Many have proposed changes to the program to move away from the "pay-as-you go" system where retirees' benefits are paid by current workers.

Argentina's pension system makes for a striking example of the pernicious effects of pay-go on federal budgets. On November 20th, a long running Argentine experiment in personal retirement accounts collapsed as the government nationalized the vast sums of money held in personal accounts.

In October, Argentine President Cristina Fernandez de Kirchner announced a plan to nationalize the $24 billion in assets held in individual pension savings accounts and return those funds to the government-run program. Now the Argentine Senate has provided final Congressional approval, ending Argentina's 14-year experiment allowing pension contributions to be invested in the private market.

Prior to the bill's passage, Argentines were allowed to invest part of their state-mandated pensions in the private stock and bond markets through the government run AFJP management program. The program, begun in 1994, was similar in spirit to the 2005 proposal put forth by President Bush to modify Social Security. Both plans were optional programs that allowed retirees to diversify their portfolios.

Under the traditional Argentine system, Argentine citizens pay taxes while working in exchange for an annuity upon retirement, similar to Social Security. While analysts in the U.S. discuss the Social Security "trust fund" (and its likely exhaustion in 2041) the balance is only an accounting mechanism. As David John of the Heritage Foundation points out, the trust fund is not even held as dollars, but rather as special Treasury bonds that are essentially IOUs. Not only are future benefits owed against those IOUs, but by counting the Social Security payroll taxes as revenue the government has been able to fund spending. Benefits are only deducted from the budget as they are paid out, ignoring that recent retirees hold claim to decades worth of benefits. "After crediting the trust fund with the proper amount in IOUs, the government spends the extra Social Security tax collections just like any other tax revenue--to finance anything from aircraft carriers to education research," explained Mr. John.

This accounting myth is exactly the feature that Fernandez hopes to imitate. Following a currency crash in 2001, Argentina's access to international capital has been scant. According to The New York Times, the government now owes $22.4 billion in debt obligations over the next year, only slightly less than the value of the nationalized pension funds. Government officials deny that the move is an attempt to reclaim assets for the budget but is instead designed to protect pensions.

"Social Security can't depend on the risks of the financial system and speculation," Senator Fabian Rios of the ruling Peronist party told senators, according to Bloomberg. Yet in the days leading up to the decision the Argentine government moved aggressively to repatriate all assets pensioners held in foreign funds. Argentines claim to $500 million in funds held in New York has been stalled by a U.S. District judge, who has frozen the assets.

While markets do carry risk, Argentines should also be aware that investing in their government does, too; the government has been forced to delay pensions to deal with its debt. In 2001, after Argentina was denied an IMF loan, the BBC reported that Argentina postponed payments to 1.4 millions pensioners (on the same pay-go plan they will now mandate) to service its debt obligations.

Might the same thing happen here? While a U.S. currency crash is unlikely, challenges to the credit rating of U.S. Treasuries are emerging.

"There is not God-given gift of a 'AAA' rating, and the US has to earn it like everyone else," said Standard & Poor's President in September interview with Reuters. A downgrade in this rating would hamper the U.S.'s ability to borrow against the IOUs that it holds to pay Social Security benefits.

In October, a proposal before the House Education and Labor Committee asked Congress to 'protect' U.S. retires from market risk. The plan would remove tax incentives for 401(k)s and encourage workers to save in government accounts. If passed, both Argentina and the U.S. would have reason to believe that they have a lot more money to spend...until retirement benefits come due.


Adam Paul is a policy researcher living in Washington, DC.

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