The Social Security Sector and Its Financing in Developing Countries

Franco Reviglio * HE SOCIAL SECURITY SECTOR plays an important economic Tand social role in many developing and developed countries. Al- though most developing countries are still at the beginning of the process aimed at increasing the size of the social security sector, there are indica- tions that they are moving fast on the same road followed by developed countries. Social security programs have been introduced and expanded because of the inadequacies of older systems,1 the development of a new ethic, and the tendency of social security expenditures to grow with per capita national income. Growth of funded programs can also be explained by their role in mobilizing resources for investment.2 With special reference to the developing countries,3 this paper intends (1) to measure the importance of the social security sector 4 and (2) to

* Mr. Reviglio, a graduate of the University of Turin, howf on the faculty of economics of Urbino University, was an economist in the Fund's Department of Fiscal Affairs when this paper was prepared. He is the author of La teoría délia curva di domanda e gli effetti delle imposte (Milán, 1965) and Saggio sulla sicurezza sociale in relazione alio sviluppo económico (Milán, 1967). 1 This need is pointed out by V.K.R.V. Rao in his Welcome Speech to the Seminar on Social Welfare in a Developing Economy, held by the India Planning Commission at New Delhi, India, September 22-26, 1963. See also Amar N. Agarwala, Insurance in India: A Study of Insurance Aspects of Social Security in India (Allahabad [I960]), pp. 398 ff.; and J. Henry Richardson, Economic and Financial Aspects of Social Security (London, I960), p. 39. 2 Franco Reviglio, "Social Security: A Means of Savings Mobilization for Economic Development," Staff Papers, Vol. XIV (1967), pp. 324-68. 3 On the financial and economic aspects of social security in the process of economic development, the literature is quite limited. In general, see Organiza- tion of American States, Social Security and Economic Development, Eleventh Inter-American Conference (Washington, 1960); International Bank for Recon- struction and Development, Financial Aspects of Social Security in Latin America, (Washington, 1962); U.S. Department of State, Agency for International Development, The Role of Social Security in Developing Countries (Washington, December 1962); Alan R. Prest, Public Finance in Underdeveloped Countries (London, 1962); Bent Hansen, "Tax Policy and Mobilization of Savings," in Government Finance and Economic Development (papers and proceedings of the Third Study Conference on problems of economic development, Athens, 1963), Alan T. Peacock and Gerald Hauser, eds., Organization for Economic Coopera- tion and Development (Paris, 1965), pp. 143-55. 4 The scope of the social security sector used in this paper covers national provident funds, national health programs, and government programs providing a considerable amount of free medical care directly to all residents, compulsory insurance, family allowances, and special programs for public employees (see Reviglio, op. cit.). 500

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 501 review alternative methods of financing social security in developing countries as to their impact on income redistribution and economic growth. In this way, it will convey a better understanding of the actual and the potential role of social security as a means of savings mobilization for economic development.

I. Importance of Social Security Receipts and Expenditures

RELATION OF SOCIAL SECURITY RECEIPTS AND EXPENDITURES TO GROSS NATIONAL PRODUCT The importance of the social security sector in the national economy can be measured by the relation of social security receipts and expenditures to the gross national product (GNP). Table 1 compares total social security cash receipts and receipts net of government payments5 with GNP in 59 countries. Data on total social security cash receipts and cash receipts excluding government payments are available for 40 developing countries for a recent year.6 They show that total social security cash receipts averaged 2.5 per cent of GNP, with a median of 1.7 per cent. Exclusion of government transfers (necessary to consoli- date the social security and public sectors) reduces the average ratio of the receipts for the 34 countries for which data are available from 2.65 per cent of GNP to 1.9 per cent, and the median from 1.7 per cent to 1.1 per cent. Total cash receipts exceeded 1.9 per cent in 16 countries and ranged from 0.1 per cent (Burma) to 12.6 per cent (Uruguay). In Chile and Uruguay the percentages approached the highest attained in the developed countries. In 19 developed countries, total social security cash receipts represented higher percentages of GNP than in most of the developing countries. They ranged between 4 per cent of GNP (Japan) and 13.7 per cent (Germany) ; receipts net of government payments ranged between 1.3 per cent (Ireland) and 9.9 per cent (the Netherlands). Gross receipts averaged 9.1 per cent of GNP, and net receipts 5.3 per cent. It is of interest to compare country differences in the ratio of social security cash receipts to GNP and the ratio of social security outlays to GNP (Table 2). According to the definitions used in this paper, social security generally excludes public health expenditures when a program 5 Government payments as employer, subsidy, and interest on public debt held by social security institutions. 6 Throughout this paper, data given for Malaysia cover only the States of Malaya.

©International Monetary Fund. Not for Redistribution 502 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 1. SOCIAL SECURITY CASH RECEIPTS: * RELATION TO GROSS NATIONAL PRODUCT, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Cash Receipts Excluding Total Cash Receipts Government3 As a Asa per cent per cent Year Amount of GNP Amount of GNP

Developed countries Japan 1960/61 685,265.0 4.0 510,837.0 3.0 Spain 1960 25,804.0 4.2 22,710.0 3.7 United States 1959/60 22,712.0 4.5 19,477.0 3.9 Portugal 1960 3,868.8 5.6 3,191.4 4.6 Iceland 1960 595.2 7.4 219.7 2.7 Finland 1960 1,217.5 7.7 614.5 3.9 Canada 1959/60 2,792.9 7.7 861.6 2.4 Switzerland 1960 2,839.5 7.7 2,186.7 5.9 Ireland 1959/60 54.6 8.3 8.8 1.3 Denmark 1959/60 3,621.6 8.8 768.3 1.9 United Kingdom 1960/61 2,401.1 8.8 1,043.9 3.8 Norway 1959/60 2,979.7 9.2 1,636.0 5.1 Sweden 1960 6,986.1 10.9 2,217.7 3.5 France 1960 34,849.7 11.8 25,575.3 8.6 Netherlands 1960 5,159.5 12.1 4,228.7 9.9 Belgium 1960 75,075.3 13.1 45,883.8 8.0 Austria 1960 21,354.0 13.2 15,298.0 9.5 Italy 1960 2,640,294.0 13.2 1,932,266.0 9.7 Germany 1960 40,537.0 13.7 27,605.0 9.3

Developing countries Burma 1963/64 12.0 0.1 8.2 0.1 Nigeria 1963 3.7 0.33 2.9 0.23 China, Republic of 1960 203.8 0.4 136.4 0.3 Honduras 1964 3.4* 0.4 2.6 0.3 Upper Volta 1960 275.0 0.63 188.0 0.43 Mali 1962 433.2 0.63 388.9 0.63 Mauritania 1962 165.8 0.7 134.4 0.6 Venezuela 1962 207.1 0.8 191.1 0.7 Nicaragua 1962/63 27.3 0.8 El Salvador 1960 13.2 0.9 5.3 0.4 Guatemala 1959/60 10.1 1.0 7.3 0.7 Colombia 1963 406.4 1.0 265.7 0.6 Morocco 1964 120.0 1.0 Senegal 1962/63 1,546.0 1.05 1,096.0 OJ5 Dominican Republic 1962 8.7 1.1 India 1959/60 1,605.7 1.1e 889.5 0.6 β Libya 1960 0.7 1.15 0.7 I.I« Ghana 1959/60 6.4 1.4 0.2 — Malagasy Republic 1960 1,973.0 1.55 695.0 0.55 Dahomey 1962 583.8 1.7 352.3 1.05

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 503 TABLE 1 (concluded). SOCIAL SECURITY CASH RECEIPTS: * RELATION TO GROSS NATIONAL PRODUCT, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Cash Receipts Excluding Total Cash Receipts Government 2 As a As a per cent per cení Year Amount of GNP Amount of GNP

Developing countries (concluded) Philippines 1963 297.9 1.7 189.47 1.1 Paraguay 1962 783.5 1.8 712.1 1.6 Congo (Brazzaville) 1963 676.1 1.9 640.4 1.8 Tanzania 1959/60 3.7 1.9 0.4 0.2 Algeria 1964 285.0 2.0 Mexico 1963 3,966.0 2.1 2,801.0 1.5 Turkey 1963 1,591.0 2.3 Bolivia 1963 161.9 2.8 87.8 1.5 South Africa 1959/60 143.5 2.7 72.4 1.3 Argentina 1962/63 64,000.0 3.7 54,300.3 3.1 Costa Rica 1963 131.2 3.8 78.8 2.3 Brazil 1963 368,100.0 3.9 325,100.0 3.4 Panama 1963 24.2 4.4 15.6 2.9 United Arab Republic 1963/64 84.0 4.5 68.6 3.6 Ecuador 1963 790.6 4.6 686.3 4.0 Israel 1960/61 244.6 4.7 221.6 4.3 Malaysia 1960 284.3 4.8 105.3 1.8 Ceylon 1962/63 332.1 4.8 72.5 1.0 Chile 1962 683.2 10.4 446.9 6.8 Uruguay 1963 2,825.9 12.6 2,501.8 11.1

Source: See Reviglio, op. cit., Appendix. 1 Public health services are generally excluded from social security cash receipts when programs of sickness insurance have been established. They have been included in the data for some countries: (1) Canada, Finland, Ireland, Norway, Sweden, and the United Kingdom, because only cash benefits for sickness are ordinarily provided through social insurance, whereas medical services are furnished by the Government under a program open to all residents; (2) Denmark, because public health expenditures involve a large subsidy to hold the hospital bills low for all residents; (3) Ceylon, Ghana, Malaysia, and Tanzania, because the Government provides substantial free medical care to all residents. 2 That is, excludes government payments of contributions as employer, for subsidies, and, when available separately, for interest on public debt held by the social security institutions. 3 Estimated. 4 Excludes government pensions for which information is not available. 5 GDP at factor cost. 6 National income. 7 Government payments have been estimated on the basis of previous years.

©International Monetary Fund. Not for Redistribution 504 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 2. SOCIAL SECURITY EXPENDITURES: RELATION TO GROSS NATIONAL PRODUCT, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Social Security Expenditures 1 As a per cent Year Amount ofGNP

Developed countries Japan 1960/61 484,827.0 2.8 Portugal 1960 2,616.9 3.8 Spain 1960 23,788.0 3.9 United States 1959/60 19,657.0 3.9 Switzerland 1960 1,931.9 5.2 Iceland 1960 457.7 5.7 Finland 1960 1,102.8 7.0 Canada 1959/60 2,565.6 7.1 Ireland 1959/60 54.4 8.2 Denmark 1959/60 3,593.5 8.7 Norway 1959/60 2,810.5 8.7 United Kingdom 1960/61 2,372.3 8.7 Netherlands 1960 4,346.6 10.2 Sweden 1960 6,870.0 10.7 Italy 1960 2,238,571.0 11.2 France 1960 34,734.0 11.7 Austria 1960 20,086.0 12.5 Germany 1960 38,070.0 12.8 Belgium 1960 74,197.7 12.9

Developing countries Nigeria 1963 0.5 Burma 1963/64 6.2 0.—1 Honduras 1964 2.5 0.32 China, Republic of 1960 232.6 0.4 United Arab Republic 1963/64 7.7 0.4 Libya 1960 0.3 0.53 Mauritania 1962 119.4 0.5 Upper Volta 1960 226.0 0.54 Philippines 1963 97.6 0.6 India 1959/60 1,005.7 0.75 Mali 1962 494.2 0.74 Nicaragua 1962/63 21.3 0.7 Venezuela 1962 207.1 0.8 El Salvador 1960 11.8 0.8 Colombia 1963 363.4 0.9 Guatemala 1959/60 9.7 1.0 1.1 Dominican Republic 1962 8.3 4 Dahomey 1962 462.5 1.3 Turkey 1963 897.0 1.3 Ghana 1959/60 6.2 1.3 Congo (Brazzaville) 1963 487.3 1.4

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 505 TABLE 2 (concluded). SOCIAL SECURITY EXPENDITURES: RELATION TO GROSS NATIONAL PRODUCT, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Social Security Expenditures * As a per cent Year Amount of GNP Developing countries (concluded) Paraguay 1962 635.2 1.5 Malagasy Republic 1960 2,088.0 1.63 Mexico 1963 3,017.0 1.6 Algeria 1964 224.0 1.6 South Africa 1959/60 98.7 1.8 Tanzania 1959/60 3.7 1.9 Bolivia 1963 158.3 2.8 Malaysia 1960 172.7 2.9 Panama 1963 16.3 3.0 Ecuador 1963 519.8 3.0 Costa Rica 1963 113.7 3.3 Argentina 1962/63 60,800.0 3.5 Israel 1960/61 198.3 3.8 Ceylon 1962/63 270.7 3.9 Brazil 1963 383,400.0 4.1 Chile 1962 561.1 8.5 Uruguay 1963 2,723.6 12.1

Source: See Reviglio, op. cit., Appendix. 1 Excluding investments. For the coverage, see Table 1, fns. 1 and 4. 2 Excluding pensions for government employees. 8 GDP at factor cost. 4 Estimated. 5 National income. of sickness insurance has been established. However, they have been included for some countries (Canada, Denmark, Finland, Ireland, Nor- way, Sweden, and the United Kingdom) where only cash benefits are provided through social insurance for sickness, while medical services are furnished by the Government under a program open to all residents. Public health expenditures have been included also for another group of countries (Ceylon, Ghana, Malaysia, and Tanzania), where the Government provides substantial free medical care to all residents. Because of this treatment, ratios of social security expenditures to GNP must be used with caution in judging the size of social security expenditures.7 Several countries have developed systems of public health 7 For a general warning, see W. A. Honohan, "International Comparisons of Social Security Statistics," in Les Problèmes Actuariels et Statistiques de la Sécurité Sociale, Editions Internationales, Vol. 3 (Geneva, 1957-58).

©International Monetary Fund. Not for Redistribution 506 INTERNATIONAL MONETARY FUND STAFF PAPERS expenditures which are excluded from the scope of the social security sector used in this paper. Another reason for care in drawing conclusions from comparisons of social security outlays is that social security outlays include direct cash payments such as family allowances and retirement pensions, and do not take into account allowances and relief from income taxes which provide similar benefits for similar social purposes.8 Moreover, some countries have programs (e.g., in collective wage agreements) that are not included in the statistics on the social security sector. The degree of protection against some risks varies considerably. In some countries, there are private insurance, voluntary schemes, and agreements under collective bargaining covering risks that are met through centrally administered programs in other countries, whereas social security expenditures shown in Table 2 cover only public programs. For example, in the United States and the United Kingdom, contributions to private social security schemes appear to be larger than in most other countries. In the United States, these contributions amounted to about $12.3 billion in I960,9 or 2.4 per cent of GNP; in the United Kingdom, total expenditures made by enterprises for social services partly financed by employees' contributions were estimated at about £1.5 billion, over 5 per cent of GNP.10 The size of social security expenditures—it could be maintained— should not be taken as a measure of the value of the offered services. The expenditures include cash benefits (transfers to beneficiaries), transfers of goods (such as drugs) purchased by the private sector or produced directly by the institutions, and administrative costs (mostly salaries and wages). These components are valued at their cost to the institutions and not according to the value at market price to the beneficiaries. In social security expenditures there is no market mechanism through which the supply of social security benefits is controlled by consumers' preferences.11 However, through democratic processes, citi- zens can, in principle, influence the decisions made by the institutions, 8 The view that no distinction can be made between implicit and explicit payments for social purposes is stressed by the United Nations, Economic Bulletin for Europe, Vol. 4, No. 2 (Geneva, 1952); A. T. Haynes and R. J. Kirtpn, "Income Tax in Relation to Social Security," Journal of the Institute of Actuaries, Vol. LXXII, Pt. 1, No. 333, 1944; and other authors quoted by Richard M. Titmuss, Essays on 'The Welfare State' (London, 1958), p. 45. 9 Margaret S. Gordon, The Economics of Welfare Policies (New York and London, 1963), p. 21. 10 Peter Townsend, "Freedom and Equality," New Statesman, Vol. LXI (1961), p. 574. 11 This function of the price mechanism is discussed in the literature on the optimal allocation of resources between public and private wants (e.g., Richard A. Musgrave, The Theory of Public Finance (New York, 1959), pp. 6 ff.).

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 507 on grounds of both efficiency and consistency with their choices, although they may have some difficulty in exerting their influence.12 In the developing countries studied, ratios of social security expenditures to GNP were generally lower than ratios of social security receipts, but they varied widely because of differences in the relative liberality of benefits provided in the national programs. In the United Arab Repub- lic the ratio of receipts to GNP was 4.5 per cent, against 0.4 per cent for expenditures; in Turkey the corresponding ratios were 2.3 and 1.3 per cent, in Panama 4.4 and 3.0 per cent, in Israel 4.7 and 3.8 per cent, in Ecuador 4.6 and 3.0 per cent, in Malaysia 4.8 and 2.9 per cent, and in Chile 10.4 and 8.5 per cent. These are the countries in which the long-term risk programs provide large surpluses available for investment. The extremes were represented by Burma (0.1 per cent for both ratios) and Uruguay (11.1 per cent for receipts and 12.1 per cent for expenditures). In the developed countries studied, ratios of social security expenditures to GNP were generally close to the ratios of social security receipts to GNP, owing to the relative insignificance of fund accumula- tions.

RELATION OF SOCIAL SECURITY EXPENDITURES TO PUBLIC EXPENDITURES Social security expenditures are a major item of public expenditures, particularly of social public expenditures having important economic effects on welfare and growth.13 They constitute the most important class of transfer expenditures in developed countries, as well as in a large group of developing countries, where they occupy the place that once was held by interest payments on the public debt. Social security expenditures represented over one fifth of general government current expenditures in 18 of the 19 developed countries considered and over one third in 11 of these countries (Table 3). In 22 developing coun- 12 Moreover, when the price of drugs and medical services (extrahospital) is zero, the political choices produce a supply which is below the demand of individuals as consumers, with a decline in the quality of the services and congestion effects. This argument, discussed by James M. Buchanan in relation to the British National Service, is used by this author to support several proposals for reorganiza- tion so as to limit free services to individuals (The Inconsistencies of the National Health Service, Institute of Economic Affairs, Occasional Paper No. 7 (London, 1966)). On uncertainties which enter into the political processes, see J.G. Head, "On Merit Goods," Finanz-Archiv, Vol. 25 (1966), pp. 23 ff. 13 With reference to the developing countries, see United Nations, Bureau of Social Affairs, Assistance to the Needy in Less-Developed Areas (New York, 1956), and United Nations, Measures for the Economic Development of Under- Developed Countries, Report by a Group of Experts appointed by the Secretary General of the United Nations (New York, 1951), pp. 51 ff.

©International Monetary Fund. Not for Redistribution TABLE 3. SOCIAL SECURITY EXPENDITURES: RELATION TO GENERAL GOVERNMENT CURRENT EXPENDITURES, SELECTED COUNTRIES, RECENT YEAR (Amount in millions of national currency) Social Security Expenditures as a Per Cent of General General Government Government Current Current Country Year Expenditures Expenditures Developed countries United States 1959/60 119,300 16.5 Japan 1960/61 2,228,000 21.8 Portugal 1960 10,760 24.3 Canada 1959/60 8,692 29.5 Iceland 1960 1,539 29.7 Switzerland 1960 6,425 30.1 United Kingdom 1960/61 7,105 33.4 Finland 1960 3,306 33.4 Spain 1960 61,700 38.6 Ireland 1959/60 171 31.8 Norway 1959/60 8,764 32.1 Sweden 1960 17,375 39.5 France 1960 87,400 39.7 Netherlands 1960 10,672 40.7 Denmark 1959/60 8,460 41.6 Italy 1960 5,256,000 42.6 Germany 1960 81,900 46.5 Austria 1960 39,700 50.6 Belgium 1960 140,700 52.7 Developing countries Nigeria 1963 112 0.4 China, Republic of 1960 11,493 2.0 Honduras 1964 100 2.5 Dominican Republic 1962 172 4.8 Venezuela 1962 4,145 5.0 Philippines 1963 1,898 5.1 El Salvador 1960 185 6.4 India 1959/60 13,340 7.5 Colombia 1963 3,797 9.6 Guatemala 1959/60 89 10.9 Israel 1960/61 1,542 12.9 South Africa 1959/60 744 13.3 Ceylon 1962/63 2,013 13.4 Tanzania 1959/60 23 16.1 Ecuador 1963 2,951 17.6 Bolivia 1963 829 19.1 Malaysia 1960 881 19.6 Panama 1963 78 20.9 Costa Rica 1963 494 23.0 Brazil 1963 1,435,000 26.7 Chile 1962 1,398 40.1 Uruguay 1963 6,491 42.0 Sources: For government current expenditures, United Nations, Yearbook of National Accounts and Statistics, 1965, and International Monetary Fund, Inter- national Financial Statistics; for social security expenditures, Table 2. 508

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 509 tries they ranged between 0.4 per cent of government current expenditures (Nigeria) and 42.0 per cent (Uruguay), and were over 20 per cent in 5 countries, all in Latin America.

FACTORS AFFECTING COUNTRY DIFFERENCES Differences in the relative importance of social security sectors among countries reflect not only the degree of economic development but also the political decisions of the governments. This can explain why countries of similar economic development have different degrees of protection, either for the number and type of various social risks covered or for coverage of the programs. In a number of countries the social security system does not include pension schemes or provident funds but is limited to work injuries, maternity benefits, family allowances, and special programs for public employees.14 In other countries the system is limited to work-injury programs and special systems for public employees,15 or is limited (as in Ethiopia) to public employee programs. The countries with a high ratio of social security expenditures usually cover a greater part of the population under their programs. Only in 8 countries of a sample of 32 developing countries in a recent year did 10 per cent or more of the population contribute to social security plans; in 17 countries less than 5 per cent contributed (Table 4). In this sample with a total population of about 886 million, only about 34 million, less than 4 per cent, were contributing to some social security program. If India is excluded, the ratio is 6.4 per cent. Since many developing countries excluded from the sample have no social security program or have a program limited to government employees, this fig- ure overstates total coverage in the developing world. In 1960 only 2.7 per cent of the population of less developed countries was estimated to contribute to social security, against 23 per cent for the developed world. The population protected, including families, is estimated to be over twice that of the number of contributors; therefore about one half of the total population in the developed world is protected, in contrast to only 6.7 per cent in the developing world. Among developing countries, the highest protection was given in South and Central America (contributors represented about 7.3 per cent of total population and the protected population about 13.1 per cent) and the lowest in Asia (contributors were 1.6 per cent of the total population and the covered 14 Among these are several French-speaking African countries (Niger, Senegal,. Cameroon, Togo, and Chad) and Cambodia. 15 Among these countries are Afghanistan, Haiti, Jordan, Kenya, Korea, Saudi Arabia, Sierra Leone, Somalia, Sudan, Thailand, and Uganda.

©International Monetary Fund. Not for Redistribution 510 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 4. SOCIAL SECURITY COVERAGE: SELECTED DEVELOPING COUNTRIES,! RECENT YEAR

Per Cent Number of of Total Year Contributors Population

Burma 1962 128,900 0.5 Dahomey 1962 11,900 0.5 Honduras 1962 24,000 1.2 India 1963 6,620,0002 1.4 El Salvador 1961 39,0002 1.5 Nicaragua 1964 35,943 2.3 Senegal 1964 ΙΟΟ,ΟΟΟ2 2.9 Bolivia 1962 110,3413 3.1 Colombia 1964 557,0004 3.2 Paraguay 1964 661,000 3.4 Ivory Coast 1965 125,0002 3.4 Morocco 1965 450,000 3.5 Turkey 1960 1,000,000 3.6 Ecuador 1961 169,000 3.8 Philippines 1963 1,078,000 3.9 Venezuela 1961 311,000 4.1 China, Republic of 1960 500,000 4.7 Mexico 1963 2,000,000 5.0 United Arab Republic 1964 1,640,000 5.7 Brazil 1962 4,810,000 6.5 Guatemala 1962 266,0005 6.6 Peru 1961 720,900 7.0 Panama 1961 80,416 7.4 Costa Rica 1963 103,000 7.7 Nigeria 1965 500,000 10.0 Ceylon 1964 1,325,000 5> 6 12.1 Dominican Republic 1963 437,0005 12.9 Malaysia 1964 1,437,790 5, β 18.4 Chile 1960 1,847,000 22.9 Israel 1963 790,0007 33.2 Argentina 1961 5,750,000 27.4 Uruguay 1962 1,060,000 40.6

Sources: Population figures from United Nations, Statistical Yearbook, 1965. Other information mainly from Daniel S. Gerig, "Social Security in the New African Countries," Social Security Bulletin, U.S. Department of Health, Educa- tion, and Welfare, Social Security Administration, Vol. 29, January 1966, pp. 29- 41; Pan American Union, Department of Social Affairs, Estudio Social de América Latina, 1963/64 (Washington, 1964); and Reviglio, op. cit., p. 325. 1 For bibliography on the existing programs, see Reviglio, op. cit., pp. 362-65. 2 Pension fund only. 3 Excludes petroleum workers, oilmen, and military employees. 4 Main social security institution only. 5 Excludes government employees, covered by special systems for pensions. 6 But all residents are covered by the National Health Program. 7 But about three fourths of the population are covered by the sickness fund.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 511 population 1.8 per cent).16 In Africa both contributors and the protected population were 4.8 per cent of the total population. This low coverage may be objectionable on equity grounds, but it can be explained on economic, administrative, and financial grounds. Coverage is restricted by the prevalence of a large agricultural and small monetary sector, dispersed settlements, internal migrations, difficulties of communications, inadequate medical personnel and facilities outside the large cities, and limited financial resources.

II. Social Security Financing and Tax Structure

BASIC METHODS OF FINANCING SOCIAL SECURITY PROGRAMS We shall now consider the methods of financing social security programs in developing countries and the conditions for the choice of the method.17 Conceptually, there are two basic ways of financing a social security program: (1) payroll taxes, aimed to support provident funds and insurance programs, and (2) transfers from government budgets according to the social approach. 16 Conferencia Interamericana de Seguridad Social, "La Seguridad Social en el Marco del Desarrollo Económico y Social del Continente," Memoria de Labores, Séptima Reunión (Mexico City, 1964), Vol. II, p. 242. 17 There is an extensive literature on social security financing. Among others, see E. d'Albergo, "Caratteri e Ripercussioni delle Nuove Assicurazioni Sociali," Rivista Β anearía, September 1940; Seymour E. Harris, Economics of Social Security (New York and London, 1941); Institut International de Finances Publiques, Aspects Financiers des Assurances Sociales, Travaux de l'Institut (Monaco, 1950); Lewis Merian, Karl Schlotterbeck, and Mildred Maroney, The Cost and Financing of Social Security, The Brookings Institution (Washington, 1950); Alan T. Peacock, The Economies of National Insurance (London, 1952), pp. 99 ff.; Eveline M. Bums, Social Security and Public Policy (New York, 1956); André Rouast and P. Durand, Sécurité Sociale (Paris, 1957); Richardson, op. cit.; J. Doublet and G. Lavau, Sécurité Sociale (Paris, 1961); Fédération Nationale des Organismes de Sécurité Sociale, "Les Problèmes Posés par le Financement de la Sécurité Sociale," Revue de la Sécurité Sociale, June 1961; Lello Gangemi, Finanza Pubblica (Naples, 1961), Vol. 1, P. II, Cap. VII, and "Appunti sulla Finanza délia Sicurezza Sociale," Giornale degli Economisti, November-Decem- ber 1964, pp. 812 ff.; Francesco Forte, "L'Armonizzazione Fiscale nel Mercato Comune Europeo," in Atti délia Tavola Rotonda di Venezia, Centro Italiano di Studi Finanziari (Naples, 1964); T. Higuchi, "Old-Age Pensions and Retirement," International Labour Review, Vol. 90 (1964), pp. 333-51; M. Talamona, Problemi e Prospettive del Finanziamento della Sicurezza Sociale, Camera di Commercio di Pavía (Pavía, 1964); Irving J. Goffman, "Some Fiscal Aspects of Public Welfare in Canada," Papers in Taxation and Public Finance, No. 1, Queen's University (Kingston, Ontario, 1965); and Sergio Steve, Lezioni di Scienza delle Finanze (Padova, 1965), hereafter cited as Lezioni. Specially referring to developing countries, see U.S. Department of Health, Education, and Welfare, Social Security Administration, Social Security Programs Throughout the World (Wash- ington, 1964), and International Labor Organization, The Cost of Social Security. 1958-60 (Geneva, 1964).

©International Monetary Fund. Not for Redistribution 512 INTERNATIONAL MONETARY FUND STAFF PAPERS Provident fund method Under the provident fund method, employees pay premiums, which, with additional contributions by their employers, accumulate as savings for future contingencies, such as retirement. There is no pooling of risks: everyone receives what he accumulates. National provident funds are in force in Malaysia (1951), India (1952), Singapore (1955), Ceylon (1958), Nigeria (1961), Tanzania (1964), and Ghana (1965).

Insurance method Under the pure insurance method, participants pay premiums on their salaries and wages to cover their own risks; there is no redistribution of wealth in the participating group. However, often social insurance programs involve standardization of contributions and risks so that everybody pays the same contribution.18 The premium paid by each participant is not rigidly bound to the amount of the risk, as in private insurance, so that the social insurance program averages the risks of all individuals. On the other hand, many insurance programs provide for redistribution of wealth in the participant group as in benefit- ing married persons more than bachelors and low-paid workers more than higher-paid workers. Some redistribution results when contributions are made by temporary workers or others who do not qualify for the benefits. Other redistribution results from the payment of benefits larger than the premiums paid, for example, benefits to persons who join the scheme late in life.

Social method The social method aims at providing benefits based on need and financed by those who are best able to pay. This system considers the financing of social security programs as a general government function supported by general taxation, with benefits which favor the needy. Benefits, therefore, are not bound to the payment of premiums. General programs financed through progressive tax systems may have merits, not only on grounds of equity but also, when fully financed from the general budget, on grounds of lower cost in eliminating the cost of assessment and collection of social security taxes. Costs of assessment and collection of social security taxes appear high in some countries. Not all social security programs can be properly organized according to the social method. For some programs (e.g., work-injury and unemployment protection), it seems more appropriate to use the insurance

18 Peacock, op. cit., pp. 41 ff.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 513 basis because of the high degree of risk dispersion. In fact, if these programs were financed by general taxation, the industries with a high risk coefficient would be favored against other industries, a distortion that would not be approvable on grounds of efficiency.19 The desirability of financing a family allowance program through general taxation can also be debated. General programs of family allowances financed out of consolidated revenues are in force in the United Kingdom, Canada, and the Scandinavian countries, where programs cover the entire population. Contributory systems are in effect in most of the other European countries, in 20 French-speaking African countries, and in some Asian and Latin American countries, such as Cambodia, Iran, Israel, Lebanon, Argentina, Bolivia, Brazil, Chile, Colombia, and Uruguay. A general family allowance program is aimed at two main goals: (1) to encourage the full development of human resources and (2) to redistribute income from high-income families to lower-income families. It does not seem reasonable, therefore, to put the burden of financing directly on employers and workers to achieve these aims. On the other hand, payroll taxes may be suitable when the program is limited to dependents of employed persons; in this case, the income redistribution is effected only within the group of those paying the premiums, and it may be unfair to ask other groups to finance the program. Unless the program of family allowances is general, the pension and sickness programs remain the principal fields of application of the social approach.20 Apart from family allowances with general coverage, an evolution in favor of the social method can be clearly seen in some of the more developed countries for sickness programs, especially for medical and hospital assistance. The concept of social insurance, established for the benefit of a particular group of the population, with medical and hospital services proportional to the payments made by the contributor, sometimes integrated with government transfers, has yielded to the concept

19 The point is well developed by Sergio Steve, Lezioni, pp. 395 if., and "Pro- blemi Attuali del Finanziamento délia Sicurezza Sociale," in Fiscalizzazione degli Oneri Sociale e Riforma délia Previdenza Sociale, Istituto per la Documentazione e gli Studi Legislative (ISLE) (Milan, 1965), pp. 44 ff., hereafter cited as Fiscalizzazione. 20 Steve (Fiscalizzazione, p. 45) holds that family allowances should be financed through premiums on payroll because of their wages redistribution function. But he proposes to coordinate family allowance programs with the treatment of the family deductions for the income tax. The basic idea, discussed by Peacock (op. cit.) and by Lady Juliet Rhys-Williams in Taxation and Incentive (London, 1953), consists in giving all families an equal amount for every child and re- moving the family deductions for income taxes. In this case, income tax revenues are enhanced.

©International Monetary Fund. Not for Redistribution 514 INTERNATIONAL MONETARY FUND STAFF PAPERS of protecting most or all of the population with benefits that are not bound to the payments made. Some Nordic countries and the United Kingdom have established national health programs open to all residents and supported by the general budget. In these countries the tax systems do not present serious loopholes, administrative inefficiencies, and differences of treatment, so that the change from contributory to general budget financing has been made without psychological and administrative difficulties.21 The same evolution has not been followed for pension programs, at least for those which provide benefits beyond minimum subsistence. In fact, the Scandinavian countries have established, in addition to general pension programs supported by the general budget, supplementary programs financed by contributions. It is still commonly held in these countries that contributory financing should not be altogether abandoned for pensions which provide more than minimum subsistence. Four arguments are advanced for maintaining the insurance principle for pensions beyond minimum subsistence: (1) The total elimination of old-age risk may reduce willingness to work and to assume risk, weakening also an important motive to save. (2) Pensions can be restricted to those who contribute, because unlike other types of government benefits, such as public health, defense, roads, and education, pension programs do not have significant external economies.22 (3) Covered individuals receive benefits in relation to their payments, thereby reducing demands on the state to raise benefits arbitrarily.23 (4) Payment of the pensions does not place an unreasonable burden on the general budget in any one year because, with the building up of reserves, the costs are spread more evenly over time.24 Developing countries are generally unable to support a social security program with a general coverage, which is considered a prerequisite to financing through general taxation. In fact, except for sickness protection, no developing country has established a social security program that is wholly financed by the government budget. Sickness protection entirely financed by the government budget is provided in Ceylon, Malaysia, Ghana, and Tanzania, mainly for historical reasons—the British tradition—but it appears quite limited, one reason being the heavy burden that would be placed on the public budget. All other 21 On limits and conditions for changing to budget financing, see Steve, Lezioni, pp. 394 ff., and Fiscalizzazione. 22 This argument limits the value of one of the main reasons in support of the "social" principle for the pensions on the basis that, as A.T. Peacock pointed out (op. cit., p. 103): "It is wrong to create the illusion that in some sense insurance benefits have to be paid for while other types of benefits do not." 23 Sir William Beveridge, Social Insurance and Allied Services (London and New York, 1942), p. 103. 24 Goffman, op. cit., p. 95.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 515 developing countries that have established social security programs for one or more contingencies have adopted the provident fund or insurance method, although many have provided for government transfers to subsidize the program. The coverage is in fact restricted to a part of the population. In the beginning, it extended only to employees in the government sector and in the largest industrial enterprises; later, more people were incorporated, often with longer protection and for more contingencies, in the industrial and commercial sectors. But developing countries generally exclude, in addition to independent workers, persons engaged in agriculture, particularly those who are not wage earners. Under these conditions, contributory financing seems generally suitable. In fact, in most developing countries, because of the regressivity of the existing tax systems, financing through the budget would not make for a more equitable distribution of the tax burden than a program based on payroll taxes. It would be particularly unfair to support with general taxation a part of the population which already enjoys better economic conditions in relation to the unprotected portion (generally those not earning wages). Moreover, payroll taxes can be justified if the proceeds are used for public investments in infrastructures or industrial investments to increase future income and consumption.25

CONTRIBUTORY FINANCING IN DEVELOPING COUNTRIES Both provident funds and social insurance programs are generally financed by premiums paid jointly by employers and employees at a fixed percentage of the payroll. Frequently, for purposes of convenience, the tax is not applied to the actual earnings of every participant but is based on several wage classes, or the rate of the premium is calculated within the limits of certain ceilings. In 46 developing countries, rates of premiums for employers and employees (1964) ranged from 4.0 per cent of payrolls in the Republic of China and Burma to 42.5-48.8 per cent in Chile (Table 5). They averaged 15.1 per cent of payrolls, with a median of 11.8 per cent. This level is considerably lower than the premium rates in several developed countries (e.g., Germany, the Netherlands, Belgium, France, and Italy) where the social security sector is still organized on the insurance basis (Table 6). In 4 countries (United Arab Republic, Bolivia, Uruguay, and Chile), social security taxes exceeded 30 per cent of payrolls, a very high level reached by few European countries (e.g., the Netherlands, Belgium, France, and Italy). 25 In favor of this approach in justification of regressive taxation, see E. d'Albergo, in "Paradossi sul Ruólo del Fattore Fiscale nella Determinazione del 'Reddito d'Impresa,'" in Studi in Memoria del Prof. Gino Zappa (Milan, 1961), Vol. I, pp. 636 ff.

©International Monetary Fund. Not for Redistribution 516 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 5. SOCIAL SECURITY TAX RATES ON EMPLOYEES AND EMPLOYERS, SELECTED DEVELOPING COUNTRIES, 1964 (In per cent)

Employees' Employers' Rates on Wages Rates on and Salaries Payroll x Total Rate

China, Republic of 1.0 (2.8 self-employed) 3.0 4.0 2 Burma 1.0 3.0 4.0 2 Pakistan 2.0 4.0 6.02 Philippines 2.5 (1.0-2.0 for low wages) 3.5 6.0 2, 3 Guatemala 2.0 5.0 7.0 Honduras 2.5 5.0 7.52 Congo, Democratic Rep. of 3.0 4.5 7.52 Dominican Republic 2.5 5.0 7.5 2» 3 El Salvador 2.5 5.0 7.52 Venezuela 2.9 3.5-6.4 6.4-9.3 2 Israel 1.7* 5.6-8. 15 7.3-9.8 2' 6 Ivory Coast 1.2 6.92 8.122,3 Mali 1.6 7.5 9.1 2, 3 Malaysia 5.0 5.0 10.0 3 Tanzania 5.0 5.0 10.03 Ceylon 5.0 5.0 10.0 2, 3 Nigeria 5.0 5.0 10.0 2, s Malagasy Republic — 7.2-13.2 7.2-13.2 2 Congo (Brazzaville) 1.6 8.9 10.52 Nicaragua 3.0 7.5 10.52 Central African Rep. 1.4 8.6-9.6 10.0-1 1.0 2 Senegal 1.2 8.0-12.0 9.2-13.2 2, τ 6.8 11.22 Libya 4.4 2 Dahomey 8 10.2-13.2 10.2-13.2 3 Panama 5.0 7.0 12.0 Costa Rica 5.5-6.5 5.5-7.5 11.0-14.03 Mexico 3.75 7.7-13.1 11.45-16.852 Upper Volta 1.8 8.5-11.7 10.3-20.2 2 Morocco 2.5 13.0 15.5 2, s India 7.0 8.75 15.75 2 3 Colombia 4.0-4.5 12.0-13.0 16.0-17.5 > Ecuador 8.0 9.5 17.5 2, s Ghana 5.0 12.5 17.5 3 Iran 5.0 13.0 18.0 Guinea — 18.2 18.22 Paraguay 6.0 13.0 19.0 Brazil 8.0 14.0 22.0 2, 3 Syrian Arab Republic 7.0 14.5-17.0 21.5-24.0 Argentina 5.0-12.0 7.5-21.0 12.5-33.0 3 Tunisia 5.0 17.0-20.0 22.0-25.0

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 517 TABLE 5 (concluded). SOCIAL SECURITY TAX RATES ON EMPLOYEES AND EMPLOYERS, SELECTED DEVELOPING COUNTRIES, 1964 (In per cent)

Employees' Employers' Rates on Wages Rates on and Salaries Payroll * Total Rate

Algeria 4.5 19.75 24.25 2» 3 Turkey 9.0-10.7 11.5-19.1 20.5-29.8 2 United Arab Republic 10.0 9 23.010 33.0 Bolivia 7.5 28.0 35.5 Uruguay 13.0-18.0 25.5-26.5 38.5-44.5 3 Chile 6.0^-7.0 " 36.5-41.8 42.5-48.8

Sources: U.S. Department of Health, Education, and Welfare, Social Security Administration, Social Security Programs Throughout the World, 1964 (Washing- ton, 1964) and Social Security Bulletin, various issues; Gerig, op. cit.; and J0rgen R. Lotz, "Taxation in the United Arab Republic," Staff Papers. Vol. XIII (1966), pp. 121-53. 1 Excludes premiums paid by the Government as employer to finance the special pension system for public employees. 2 This percentage is generally on a maximum basis. 3 Plus whole cost of work-injury program. 4 5.2 per cent of self-employed, plus about 1 per cent of sickness fund. 5 Plus about one half of sickness fund. 6 Plus 80 per cent of sickness fund. 7 Pensions for government employees are financed mostly by the employees; pensions for government workmen by the employees (40 per cent) and by the Government (60 per cent). 8 The Government finances a pension fund for government employees with a contribution of 14 per cent of wages and salaries. This rate has not been included in this table. 9 12.0 per cent for government employees. 10 21.0 per cent for government employees. 11 9.0 per cent for salaried employees.

Premium rates for employers are generally more than twice as high as those for employees. In 46 developing countries the employees' contributions averaged 4.2 per cent of wages and salaries, against 10.5 per cent of payrolls for employers' contributions. Moreover, employers generally have to finance the whole cost of work-injury programs. In 30 of the 46 countries, maximum earnings for the calculation of contributions are established. REGRESSIVITY AND EFFICIENCY DISTORTIONS OF SOCIAL SECURITY TAXES Before considering the implications for developing countries, of the argument of regressivity (which is generally raised against payroll taxes),

©International Monetary Fund. Not for Redistribution 518 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 6. SOCIAL SECURITY TAX RATES ON EMPLOYEES AND EMPLOYERS, SELECTED DEVELOPED COUNTRIES, 1964 (In per cent)

Employees Employers Total

Sweden 4.0 * 8.52 12.53 Netherlands 12.5-16.5 10.8-20.8 2 23.3-37.3* Germany 11.65-13.15 13.15-14.65 24.8-27.8» Belgium 9.8 21.552 31.356 France 6.0 27.752 33.757 Italy 6.15 40.55-48.15» 46.7-54.38

Sources: See Table 5. 1 Plus contributions of about one half the cost of sickness and maternity benefits and one third of unemployment insurance. 2 Plus whole cost of work-injury insurance. 3 Maximum income for old age, SKr 30,000 a year. 4 Maximum earnings for contribution, f. 10,400 a year per person under work- injury and family-allowance programs. 5 Maximum monthly contribution for old age, invalidity, and death DM 1,550; for sickness and maternity DM 900, and unemployment DM 750. 6 Maximum monthly contribution for pension BF 9,000 and for sickness and maternity, unemployment, and family allowances BF 11,825. 7 Maximum basis, F 970 a month. 8 Family allowance contributions ( 17.5 per cent) are related to a maximum basis (Lit 17,500 a month). we shall discuss some distortions that can be produced by contributory financing. Under certain circumstances, high premiums can produce undesirable economic and social effects. Under inflationary conditions, when an automatic escalator clause exists for wages and salaries, determination of contributions on the basis of a fixed percentage of payrolls can have a cost-push effect.26 An inflationary impact on the demand side may result when the flow of the benefits is not offset by the deflationary impact of the payment of the contributions if, as seems reasonable, a part of the premiums is paid out of savings, whereas all benefits represent an increase in consumption expenditures. On the other hand, an increase in social security receipts owing to inflation can have a stabilizing effect when it reduces the level of consumption. In some Latin American countries, when money has been scarce during inflation (or deflation), high premium rates, together with a low interest rate on overdue payments, have encouraged delinquency in the employers' payments. Employers in many developing countries lag in the payment

26 P. Armani, "Problemi Economic! e Finanziari," in Per un Sistema di Sicurezza Sociale in Italia, Comitato di Studio per i Problemi Sociali (Bologna, 1965), p. 275.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 519 of social security premiums and use the premiums as a source of financing for their own company operations; some of them not only fail to pay their own contributions but also retain the premiums withheld on employees' wages and salaries. Employer delinquency reaches unusual proportions in some countries, such as Argentina, Bolivia, Brazil, Para- guay, and Uruguay. In Argentina (1964), accumulated overdue premiums were estimated at M$N 45 billion (compared with M$N 92 billion for total receipts); in Paraguay (1962) the principal institution had accumulated claims on employers for 0 46.8 million (compared with 0 783 million for total receipts). In Uruguay, Bolivia, and Brazil the ratio of the increase in employers' delinquency to total cash contributions in a recent year ranged from at least 2.4 per cent to 13.0 per cent (Table?).

TABLE 7. INCREASE IN EMPLOYERS' DELINQUENCY IN SOCIAL SECURITY PAYMENTS: RELATION TO TOTAL CASH SOCIAL SECURITY RECEIPTS, THREE DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Increase in Employers* Delinquency As a per cent of Year Amount total cash receipts

Bolivia 1963 20.1 12.8 Brazil 1963 33,400.0 13.0 Uruguay 1964 60.01 2.4

1 Excludes large claims of the Industries and Trade Fund, for which information is not available. Sometimes the government implicitly permits delinquency as a means of overcoming the financial difficulties of the enterprises, but, in doing so, it relinquishes the opportunity to direct the flow of credit in the public interest to selected industries or enterprises. Arguments have been raised against the distribution effects of contributory financing and the way the amount of contributions is calculated. Social security contributions of employers and employees are probably regressive as to personal incomes.27 A flat-rate contributory system pays no regard to individual circumstances and excludes from the tax base important components of total income, such as rents, interest, and 27 On this conclusion, see Alfred H. Conrad, "Redistribution Through Govern- ment Budgets in the United States, 1950," in Income Redistribution and Social Policy, Alan T. Peacock, ed. (London, 1954), p. 208; Earl R. Rolph and George F. Break, Public Finance (New York, 1961), pp. 397 fiv, and Richard A. Musgrave, "Estimating the Distribution of the Tax Burden," in Income Redistribution and the Statistical Foundations of Economic Policy, Income and Wealth, Series X, Colin Clark and Geer Stuvel, eds. (London, 1964), pp. 186-219.

©International Monetary Fund. Not for Redistribution 520 INTERNATIONAL MONETARY FUND STAFF PAPERS dividends; and the ceilings on contributions exclude wages and salaries in the higher brackets. Therefore, social security taxation, unlike personal income taxation, is contrary to equity and ability-to-pay princi- ples.28 Moreover, social security benefits are generally tax free;29 they are worth much more than their face value to persons in high-income brackets, and this can worsen the regressivity of social security taxes. The degree of regressivity of payroll taxes is determined by their incidence. The incidence of the tax on employees depends on a country's stage of development and on its economic and social conditions, as well as on the extent of the coverage of the programs. In general, employees can shift their portion of the tax only if there are alternative employment opportunities in a sector not subject to the tax. In developing countries, payroll taxes are not general but are limited mostly to the government sector and the more advanced industrial sector. Because of limited alternatives of employment not subject to the tax, a general payroll tax on employees in a developed country is likely to be borne by the wage earner. Against this conclusion it could be objected that if we assume the existence of unlimited supply of unskilled workers and of disguised unemployment in agriculture,30 we can expect that payroll taxes in the long run will be shifted to employers or to consumers because the basic wage level is determined by the average earnings in the subsistence sector 28 Apparently only Sweden takes into account individual circumstances in assessing social security obligations. The lack of fairness and progression of the general system is pointed out by Titmuss, op. cit., pp. 67 ff. Henry Aaron writes that in the United States "the conflict between the contributory principle of Social Insurance and progressive rates of taxation of personal income is growing. The conflict could be overlooked so long as Social Security tax rates were only 1 or 2 per cent. When they are 4 or 5 per cent, or more if backward shifting is considered, the conflict becomes clear" ("Rate Progressivity and the Direct Taxation of Personal Income," Taxes, Vol. 44 (1966), p. 503). 29 For pensions, see W. Hasenberg, "Income-Tax Treatment of Old-Age Pen- sions and Contributions Here and Abroad," Social Security Bulletin, Vol. 29, August 1966, pp. 10-18. 30 "An unlimited supply of labour [which is assumed by the classical econo- mists from Adam Smith to Karl Marx to explain economic expansion as a product of capital accumulation] may be said to exist in those countries where population is so large relatively to capital and natural resources, that there are large sectors of the economy where the marginal productivity of labour is negligible, zero, or even negative" (W. Arthur Lewis, "Economic Development with Unlimited Supplies of Labour," The Manchester School of Economic and Social Studies, Vol. XXII (1954), p. 141); and according to Lewis, "this phenomenon [of disguised unemployment] is rare in Africa and in Latin America, but it repeats itself in China, in Indonesia, in Egypt and in many countries of Eastern ¡Europe" (The Theory of Economic Growth (London, 1955), p. 327). For the literature on the concept of disguised unemployment—that is, where the marginal productivity of labor is zero or negative—see Charles H. C. Kao, Kurt R. Ansehe!, and Carl K. Eicher, "Disguised Unemployment in Agriculture: A Survey," in Agriculture in Economic Development, Carl Eicher and Lawrence Witt, eds. (New York, 1964).

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 521 plus a difference (a premium) to meet the cost of the transfer to the market sector. This premium cannot be reduced if the existing or the required increased supply of labor is to be maintained. Therefore, although in the short run the tax on wages may not be shifted because the supply of workers is inelastic, in the long run, accepting the above assumptions, it has to be shifted. However, the realism of the assumptions of an unlimited supply of labor and disguised agricultural unemployment in some developing countries has recently stirred up a vigorous and continuing debate. It has been said that in some Latin American countries, transfer of agricultural labor has resulted in a decline in agricultural output,31 and that, in any case, there seems to be little empirical evidence of the existence of much disguised unemployment (hardly more than 5 per cent) in developing countries.32 Therefore, wages in the capitalist sector of these countries can rise far above the subsistence level; actually a wide degree of inequality in the wage structure in different industries, firms, and areas has been observed in many developing countries.33 In these conditions, it seems that the incidence of payroll taxes on workers cannot be excluded. In general, we may conclude that workers who are paid above the subsistence level plus the premium are likely to bear at least a portion of the tax. This conclusion applies particularly to government employees. The weakness of most trade unions in developing countries (compared with their relative strength in developed countries) and the infrequency of collective bargaining reinforce this conclusion. To the extent that taxes are not borne by workers, they are more likely to be shifted to profits, at least in export industries and some import-substitute industries where prices are determined by the world market. 31 Theodore W. Schultz, "The Role of Government in Promoting Economic Growth," in The State of the Social Sciences, Leonard D. White, ed. (Chicago, 1956), pp. 372-83. Schultz sees "no evidence for any poor country anywhere that would even suggest that a transfer of some small fraction, say, 5 per cent, of the existing labor force out of agriculture, with other things equal, could be made without reducing its (agricultural) production." See also Theodore W. Schultz, Transforming Traditional Agriculture (New Haven, Connecticut, and London,1964). 32 Kao, Anschel, and Eicher, op. cit. Against the existence of significantly disguised unemployment even in the most overpopulated countries, see also Jacob Viner, "Some Reflections on the Concept of Disguised Unemployment," The Indian Journal of Economics, Vol. XXXVIII (1957), pp. 17-23; and for country studies, Harry T. Oshima, "Underemployment in Backward Economies, An Empirical Comment," The Journal of Political Economy, Vol. LXVI (1958), pp. 259-64; and Bent Hansen, "Marginal Productivity Wage Theory and ¡Sub- sistence Wage Theory in Egyptian Agriculture," The Journal of Development Studies, Vol. 2 (1966), pp. 367-407. 33 H.A. Turner, "Wage Policy and Economic Development," Transactions of the Manchester Statistical Society, Paper 1-22, Session 1962-63.

©International Monetary Fund. Not for Redistribution 522 INTERNATIONAL MONETARY FUND STAFF PAPERS For payroll taxes on employers also, it is difficult to assess the incidence. Generally, it depends on the extent of the coverage, the market structure, the demand for products, the supply of labor and capital, the impact of the use of social security contributions on savings-investment and consumption patterns, and monetary conditions. In developing countries the forward shifting of the tax is limited since prices in export industries and some import-substitute industries are determined by the world market, the labor supply is elastic and labor unions are generally weak, and funded programs are relatively important. The weakness of labor unions enhances the possibility of shifting the tax to the employees.34 However, this shift can occur only if salaries necessary to attract the workers from the subsistence sector are above the subsistence level plus the premium. Under certain conditions, incidence on profits appears likely because of the difficulties of raising prices in export industries and import-substitute industries and the contraction in general consumption induced by the funded programs. On the other hand, inflationary forces in the economy make it easier for employers to raise the prices of their products to cover higher social security costs, although it is often difficult to ascribe price increases to only higher contributions rather than to monetary and credit conditions. As long as the incidence of payroll taxes is on employees, the taxes are mildly progressive in the lower ranges and regressive thereafter. The shift to consumers involves regressivity throughout most of the coverage. Effective ceilings on the contributions bring about different incidence in sectors with lower wages and salaries.35 When incidence is shifted to consumers, the balance of payments may be worsened because of the effects on the terms of trade for imports and goods produced for export. « When the incidence of payroll taxes falls on profits, premiums distort the choice between capital and labor, stimulate employers to prefer combinations of factors of production with a smaller quantity of labor, and encourage capital-intensive (or labor-saving) development. Such distortion can occur also when the incidence falls on consumers. When prices increase, enterprises that save labor may enjoy a sort of fiscal rent. Naturally this discrimination is effective only when the entrepre- neurs' choices are affected by the relative costs of labor and of capital and by the relative supply of labor. It is reasonable to expect that the higher the social security tax on employers, the more likely the rearrange- 34 For developed countries, the literature does not hold likely the incidence on profits. See, e.g., Cesare Cosciani, Istituzioni di Scienza delle Finance (Turin, 1961), p. 516; and Rolph and Break, op. cit., p. 398. 35 For the United States it has been calculated that the contributions that each worker pays as a percentage of his income are regressive when they are wholly shifted to consumers (Conrad, op. cit., and Musgrave (1964), op. cit.).

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 523 ment of the combination of factors of production in favor of untaxed goods. In a developed country, part of this efficiency distortion can be eliminated if the forward shifting of the higher labor costs also raises the prices of capital goods.36 But the similar compensatory effect would not readily occur in a developing country which must import most of its capital goods. When employers' taxes are shifted, at least partially, to wages and salaries, the distortion can be avoided. To the extent that the distortion does occur, it appears undesirable when labor is underemployed.37 Other distortions may be produced by ceilings for contributions; they can distort the choices between unskilled and skilled workers, stimulate employers to employ more skilled labor, and push employers to resort to overtime work in order to avoid the payment of the tax. While the former distortion can be acceptable because it gives incentive to the development of human resources, the latter can reduce employment. Generally, when premiums are shifted to profits, investment and employment may decline and the development of the country can be impeded. Against the charge of regressivity, it has been said that, although social security taxes are a much larger percentage of the income of the poor than of the rich, under the insurance principle the poor and the rich are paying for future benefits. This argument does not appear to be defensible when the coverage of the programs is general. It is subject to the same criticism made against financing public expenditure on the basis of the benefit principle. However, the argument appears to be better grounded when the coverage of the social security programs is limited mostly to the industrial workers and the civil service, excluding most of the lower income groups. As we have seen before, in most developing countries, social security financing from the general budget would not appear more equitable so long as the tax systems rely mostly on regressive customs and excise duties, and when progressive taxes are generally only a minor source of revenue? In general, the regressivity of social security taxes should not be judged alone but in relation to the available alternatives; it is likely that these do not have better features on equity grounds and may not have the advantages that payroll taxes 36 It is difficult to conclude that even a complete forward shifting of premiums in the price of capital goods would leave the relative cost of labor and capital wholly unaffected. There are other imports of capital equipment on which the premium would not be levied or shifted forward, so that the price of capital would not rise by the same percentage as the insurance premium in labor. 371.M.D. Little, "Tax Policy and the Third Plan," in Pricing and Fiscal Policies, P.N. Rosenstein-Rodan, ed. (Cambridge, Massachusetts, 1964), p. 45. Little believes that contributions to a provident fund are most undesirable taxes in a country in which labor is insufficiently employed. For this reason alone, the existing Indian provident funds, according to him, should not be extended.

©International Monetary Fund. Not for Redistribution 524 INTERNATIONAL MONETARY FUND STAFF PAPERS have from the standpoint of feasibility, administrative convenience, and income elasticity. Payroll taxation, therefore, finds justification from the fact that the group which contributes to the cost of the program receives the benefits. Financing benefits with payroll taxes limits vertical redistribution; in this way, the effects of the social security taxes and benefits on income redistribution are mostly confined to participants within the same income group.38 Individuals within the group may receive benefits that are larger or smaller than their contributions. The redistribution can be particularly important for family allowances, as has been shown for some developed countries, such as Italy, France, and Canada.39 The same argument may be used also in judging the opportunity for the government to subsidize social security programs. While a vertical redistribution of income from the higher to the lower income group has been achieved in some industrial countries through government subsidies to social security programs, these subsidies in most developing countries would benefit people who are better off relative to the large uncovered portion of the population. In any case, when the coverage, though not general, becomes wider and includes also the poorest portions of the population, the regressivity of the contributions can be redressed, at least partially, by devising a distribution of benefits which is not bound in a rigid accounting way to the paid contributions.40 38 On this redistribution under limited and comprehensive insurance schemes, see T. Barna, The Redistribution of Incomes Through Public Finance in 1937 (Oxford, 1948), and Income Redistribution and Social Policy (cited in fn. 27), especially T.B. Lim, "Redistribution of Income in Underdeveloped Territories," pp. 268-90. See also International Labor Office, Expanded Programme of Technical Assistance, Report on the Seminar on Social Security, made in Prague, August 1-September 10, 1959 and published as ILO/TAO/Int/R.3 (Geneva, 1960), p. 208. 39 See Steve, Lezioni, p. 356; United Nations, "Taxes on Wages or Employ- ment and Family Allowances in European Countries," Economic Bulletin for Europe, Vol. 4, No. 2, August 1952, p. 25; J.M. Jackson, "Wages, Social Income, and the Family," The Manchester School of Economic and Social Studies, Vol. XXIX (1961), pp. 95-106; Georges Rottier and Jean F. Albert, "The Social Services and Income Redistribution in France," in Income Redistribution and Social Policy (cited in fn. 27), pp. 90-138; L. Pasi, "Assegni Familiari, Occu- pazione e Reddito nei Paesi délia Comunità Económica Europea," Previdenza Sociale, January-February 1963, pp. 21 ff.; and T. Higuchi, "Income Redistribution and Social Security: Interpretation of a Japanese Survey," International Labour Review, Vol. 92 (1965), pp. 208-22; in general, Hubert Brochier, Finances Publiques et Redistribution des Revenus (Paris, 1950). The measurable extent of income redistributive effects of the Canadian program has been shown by J.W. Willard, "Some Aspects of Family Allowances and Income Redistribution in Canada," Public Policy, Vol. V (1954), pp. 225 and 227. 40 For the United States, JJ. Carroll has shown that the distribution of the benefits compensates somewhat for the regressivity of the contribution, because the share of the very lowest income groups in the benefits tends to be high (Alternative Methods of Financing Old-Age, Survivors and Disability Insurance, Institute of Public Administration, University of Michigan (Ann Arbor, I960)).

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 525 SOCIAL SECURITY FINANCING THROUGH THE GENERAL BUDGET IN DEVELOPING COUNTRIES Besides payroll taxes, government transfers form an important source of financing of social security in many developing countries. In most social security plans, the government is responsible for a certain proportion of the costs, a percentage of the combined employer-employee contributions, or for any residual cost of meeting the deficits (Table 8). Many government payments are financed by earmarked taxes. Table 9 shows, for 31 developing and 19 developed countries, payments actually made by the Government to the social security sector. These include not only payments made to support some programs, but also those made as employer of civil and military personnel.41 Employer payments by a public corporation outside the budget are generally considered in this paper as nongovernment social security tax payments. In the developed countries, government payments to the social security sector ranged between 12 per cent of total revenues of the sector (Spain) and 83.9 per cent (Ireland) and exceeded 31 per cent in 10 of the 19 countries. In the 31 developing countries, the government contribution averaged about 30 per cent of the total social security receipts, ranging from 7.7 per cent (Mali) to 89.2 per cent (Tanzania). In 6 countries (Costa Rica, Bolivia, El Salvador, Malaysia, Ceylon, and Tanzania), government payments rise to over 40 per cent of total receipts. This rate is comparable to government participation in developed countries (e.g., the United Kingdom, Ireland, Canada, and the Nordic countries) where social security programs such as medical care have been established primarily on the basis of the social principle. Malaysia, Ceylon, and Tanzania have health programs open to all residents, wholly financed by the Government through general revenues. In the other three countries, participation of the Central Government (and of the state governments in India) as employer is particularly high in relation to the low coverage of the programs for nongovernment employees. Government transfers in Costa Rica are also high. This paper also attempts to measure the burden of social security on the government budget by showing general government payments to the social security sector (contributions as employer and subsidy), as a per cent of government current expenditure (Table 10). In 23 developing countries, government social security payments ranged between 0.2 per cent of current expenditures (Nigeria) and 16.6 per cent in Malaysia, and were 5 per cent or more in 10 countries. Compared with developed countries, these proportions are relatively low. In developed 41 it would be desirable to include also interest on the public debts held by the social security sector, but these data are available for only a few countries.

©International Monetary Fund. Not for Redistribution TABLE 8. GOVERNMENT TRANSFERS TO THE SOCIAL SECURITY SECTOR, SELECTED COUNTRIES (Excludes payments made by government as employer and interest on government debt held by social security institutions)

Purpose for Which Government Transfers Country Are Made

Developed countries Belgium Subsidies to all programs (excluding work injury). France Work-injury insurance: entire cost. Germany Family allowances: entire cost; other programs: any deficit. Italy Pensions and sickness and maternity benefits: 6.65 per cent of earnings, plus special grants; family allowances: subsidy toward allowances for agricultural workers. Netherlands Pensions: contributions for low-income persons and any deficits; family allowances: entire cost of allowances for first and second child of self- employed persons, and for pensioners; unemployment: 0.6 per cent of total covered earnings; sickness and maternity benefits: subsidy for voluntary low-income contributions. Sweden Universal pension program: about 70 per cent of cost; sickness and maternity benefits: one fourth of cost; unemployment benefits: two thirds of cost; family allowances: entire cost. Developing countries Algeria Unemployment benefits: entire cost. None. Argentina 1 Bolivia 1-5 per cent of total national payroll. Brazil 8 per cent of payroll, plus 5 per cent of yield of corporate income taxes, lottery profits, and race- track wagers.2 Family allowances: whole cost for large families. Burma Sickness and maternity benefits: 1 per cent of covered earnings. Burundi None. Ceylon Sickness and maternity benefits: entire cost; work injury: cost of medical care. Chile Pensions: 5.5 per cent of wages; sickness: any deficit; maternity benefits: two thirds of total cost; work-injury insurance: grant. China, Republic of 1.2 per cent of earnings of self-employed and part of proceeds of tax on fish sales in lieu of contribution by fishermen. Colombia 4.0-4.5 per cent (pensions: 2 per cent; sickness and maternity benefits: 2-2.5 per cent). Congo (Brazzaville) Family allowances: 50 francs a month per child covered. Costa Rica 3.5 per cent of covered earnings (derived mainly from an earmarked cigarette tax).2 Dahomey Family allowances: subsidy of about one fifth of the total receipts. Dominican Republic 2.5 per cent of wages, and any deficit. Ecuador 40.0 per cent of cost of pensions paid (about 40.5 per cent of total receipts of the social security system). El Salvador Sickness and maternity benefits: 2.5 per cent of earnings. 526

©International Monetary Fund. Not for Redistribution TABLE 8 (concluded). GOVERNMENT TRANSFERS TO THE SOCIAL SECURITY SECTOR, SELECTED COUNTRIES (Excludes payments made by government as employer and interest on government debt held by social security institutions)

Purpose for Which Government Transfers Country Are Made

Developing countries (concluded) Ghana None. Guatemala 2 per cent of earnings; accident insurance: 1.0 per cent of earnings; maternity benefits: 1.0 per cent of earnings. Guinea None. Honduras Sickness and maternity benefits: 2.5 per cent of earnings. India Medical benefits for sickness and maternity: State Governments pay one fourth or one eighth of cost. Iran None. Israel Pensions: 0.57 per cent of earnings; sickness benefits: about one fifth of cost. Ivory Coast Family allowances: any deficit. Libya None. Malagasy Republic Family allowances: about one third of cost. Malaysia None. Mali Family allowances: subsidy. Mauritania Family allowances: about 20 per cent of cost. Mexico Pensions: 1.5 per cent of earnings; sickness benefits: 2.25 per cent of cost. Morocco None. Nicaragua Pensions: 3 per cent of earnings. Pakistan None. Panama 0.8 per cent of total earnings, plus proceeds of special taxes (about 0.3 per cent of earnings). Paraguay 1.5 per cent of earnings. Philippines Remaining cost and administrative expenses. Senegal CFAF 250 a month per child covered (derived from earmarked yield of part of turnover tax). Syrian Arab Republic None. Tanzania None. Tunisia None. Turkey None. United Arab Republic None. Upper Volta Family allowances: yield from part of turnover tax (about 15 per cent of cost). Uruguay Pensions: allocation from proceeds of various taxes, including those on income and bank checks; unemployment proceeds of special taxes and excises. Venezuela Cost of administration (about 12.0-15 per cent of total receipts).

Sources: U.S. Department of Health, Education, and Welfare, Social Security Administration, Social Security Programs Throughout the World, 1964, and supplemental reports; International Labour Review; and Bulletin of the Inter- national Social Security Association. 1 Provision not applied. 2 Provision only partly applied. 527

©International Monetary Fund. Not for Redistribution 528 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 9. GOVERNMENT CASH PAYMENTS TO SOCIAL SECURITY SECTOR: PER CENT OF TOTAL RECEIPTS, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Government Payments to Social Security Sector ι Total Per cent of social As As security Year employer transfers 1 Amount receipts

Developed countries Spain 1960 2,303.0 791.0 3,094.0 12.0 United States 1959/60 3,144.0 92.0 3,236.0 14.2 Portugal 1960 652.7 24.7 677.4 17.5 Netherlands 1960 539.0 391.8 930.8 18.0 Switzerland 1960 309.8 343.0 652.8 23.0 Japan 1960/61 85,755.0 88,673.0 174,428.0 25.5 France 1960 6,231.8 3,042.6 9,274.4 26.6 Italy 1960 317,207.0 390,821.0 708,028.0 26.8 Austria 1960 3,531.0 2,525.0 6,056.0 28.4 Germany 1960 6,962.0 5,970.0 12,932.0 31.9 Belgium 1960 10,953.7 18,237.8 29,191.5 38.9 Norway 1959/60 278.8 1,064.9 1,343.7 45.1 Finland 1960 163.0 440.0 603.0 49.6 United Kingdom 1960/61 80.4 1,276.8 1,357.2 56.5 Iceland 1960 34.4 341.1 375.5 63.1 Sweden 1960 431.4 4,337.0 4,768.4 68.3 Canada 1959/60 148.3 1,782.9 1,931.2 69.1 Denmark 1959/60 326.0 2,527.3 2,853.3 78.8 Ireland 1959/60 7.1 38.7 45.8 83.9

Developing countries Mali 1962 33.5 33.5 7.7 Paraguay 1962 71.4 71.4 9.1 Israel 1960/61 — 23.0 23.0 9.4 Dominican Republic 1962 0.9 0.9 10.3 Ecuador 1963 55.8 26.2 82.0 10.4 Brazil 1963 43,000.0 43,000.0 11.7 Uruguay 1964 411.9 — 411.9 12.4 Venezuela 1962 27.2 27.2 13.1 Argentina 1962/63 11,100.0 — 11,100.0 17.3 Nigeria 1962 0.2 — 0.2 18.2 United Arab Republic 1963/64 15.4 — 15.4 18.3 Mauritania 1962 — 31.4 31.4 18.9 Honduras 1964 0.8 0.8 23.5 Turkey 1960 272.9 0.1 273.0 23.9 Guatemala 1959/60 2.0 0.8 2.8 27.7

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 529 TABLE 9 (concluded). GOVERNMENT CASH PAYMENTS TO SOCIAL SECURITY SECTOR: PER CENT OF TOTAL RECEIPTS, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Government Payments to Social Security Sector ι Total Per cent of social As As security Year employer transfers 1 Amount receipts

Developing countries (concluded) Chile 1963 141.5 134.3 275.8 28.5 Senegal 1962/63 45.02 405.0 450.0 29.1 Mexico 1963 1,165.0 29.4 Burma 1963/64 '3.8 — 3.8 31.7 China, Republic of 1960 56.5 10.9 67.4 33.1 Philippines 1960 59.9 0.8 60.7 34.2 Colombia 1963 122.8 17.9 140.7 34.6 Panama 1963 8.6 35.5 Dahomey 1962 1603 50.0 211.8 36.3 India 1959/60 577.1 7.0 584.1 36.4 Costa Rica 1963 35.4 18.0 53.4 40.4 Bolivia 1963 43.8 31.14 74.9 46.3 Malaysia 1960 60.2 86.5 146.7 51.6 El Salvador 1960 6.4 1.5 7.9 59.8 Ceylon 1962/63 105.8 147.0 252.8 76.1 Tanzania 1959/60 1.1 2.2 3.3 89.2

Source: See Reviglio, op. cit., Appendix. 1 Central and local government payments as transfers cover special taxes allo- cated to social security, state participation, and participation of other public authorities. 2 Estimated. 3 Budgeted. 4 Payment made to meet the deficit of the social security institutions. Allocation of this payment as subsidy is uncertain because the Government in the same year did not pay a large amount of contributions due. countries, government social security payments ranged between 2.7 per cent of current expenditures in the United States and 33.7 per cent in Denmark; with the exception of the United States, these ratios are relatively higher than those in the first half of the developing countries.

GOVERNMENT ARREARS Governments, particularly in Latin America, often fail to meet their obligations to social security institutions because of budget deficits and

©International Monetary Fund. Not for Redistribution 530 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 10. GOVERNMENT CASH PAYMENTS TO SOCIAL SECURITY SECTOR: PER CENT OF GOVERNMENT CURRENT EXPENDITURES, SELECTED COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Government Payments to the Social Security Sector * Per cent of government current Year Amount expenditures

Developed countries United States 1959/60 3,236.0 2.7 Spain 1960 3,094.0 5.0 Portugal 1960 677.4 6.3 Japan 1960/61 174,428.0 7.8 Netherlands 1960 930.8 8.7 Switzerland 1960 652.8 10.2 France 1960 9,274.4 10.6 Italy 1960 708,028.0 13.5 Austria 1960 6,056.0 15.3 Norway 1959/60 1,343.7 15.3 Germany 1960 12,932.0 15.8 Finland 1960 603.0 18.2 United Kingdom 1960/61 1,357.2 19.1 Belgium 1960 29,191.5 20.7 Canada 1959/60 1,931.2 22.2 Iceland 1960 375.5 24.4 Ireland 1959/60 45.8 26.8 Sweden 1960 4,768.4 27.4 Denmark 1959/60 2,853.3 33.7

Developing countries Nigeria 1962 0.2 0.2 Dominican Republic 1962 0.9 0.5 China, Republic of 1960 67.4 0.6 Venezuela 1962 27.1 0.7 Honduras 1964 0.8 0.8 Israel 1960/61 23.0 1.5 Paraguay 1962 71.4 1.6 Ecuador 1963 82.0 2.8 Brazil 1963 43,000.0 3.0 Guatemala 1959/60 2.8 3.1 Colombia 1963 140.7 3.7 El Salvador 1960 7.9 4.3 India 1959/60 584.1 4.4 Philippines 1960 60.7 4.9 Uruguay 1963 324.1 5.0

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 531 TABLE 10 (concluded). GOVERNMENT CASH PAYMENTS TO SOCIAL SECURITY SECTOR: PER CENT OF GOVERNMENT CURRENT EXPENDITURES, SELECTED COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Government Payments to the Social Security Sector1 Per cent of government current Year Amount expenditures

Developing countries (concluded) Bolivia 1963 74.9 9.0 South Africa 1959/60 71.1 9.6 Costa Rica 1964 53.9 10.9 Panama 1963 8.6 11.0 Ceylon 1962/63 252.8 12.6 Tanzania 1959/60 3.3 14.3 Chile 1963 275.8 14.9 Malaysia 1960 146.7 16.6

Sources: For government current expenditures, United Nations, Yearbook of National Accounts and Statistics, 1965; for government payments to social security, Reviglio, op. cit., Appendix. 1 Employers' contributions and subsidies. inflationary or deflationary conditions and sometimes because of government failure to consider subsidies to social security institutions as necessary expenditures.42 Government arrears involve transfers (subsidies) to the social security sector, payment of premiums as employer, and in a few countries (e.g., Argentina), payment of interest on the public debt held by the social security institutions. Some governments do not meet their obligations with cash payments and issue government securities. Failure of the government to pay a substantial part of its social security obligations in cash was notable in some countries. Unpaid government obligations in a recent year represented over one fourth of the total cash receipts of the social security sector in some Latin Ameri- can countries (Nicaragua, Bolivia, Brazil, and Argentina) and over 10 per cent in Costa Rica and Uruguay (Table 11). On equity grounds, failure of the government to meet financial obligations to the social security sector has a different meaning, depending 42 The amount of the government payments due to the social security agencies often grows automatically with the increase in wages and salaries, but the general government revenue does not always grow in the same proportion.

©International Monetary Fund. Not for Redistribution 532 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 11. INCREASE IN GOVERNMENT NONCONSOLIDATED DEBT TO THE SOCIAL SECURITY SECTOR, SELECTED DEVELOPING COUNTRIES, RECENT YEAR (Amount in millions of national currency)

Increase in Government Debt As a per cent of social security Year Amount receipts

Ecuador 1959 17.0 3.2 Costa Rica 1963 13.4 10.2 Uruguay 1964 415.21 12.5 Nicaragua 1963/64 8.6 26.5 Bolivia 1963 43.8 27.4 Brazil 1963 102,500.0 27.8 Argentina 1962/63 19,600.0 30.6

Source: See Reviglio, op. cit., Appendix. 1 Only accounts due by the Government as employer.

on whether it is due to unpaid transfers as subsidy, as employer, or as interest. When social security benefits are provided only to a small part of the population (generally those who have the highest wage levels), the government subsidy actually benefits those who are relatively better off than those in the uncovered population; moreover, the subsidy is financed by tax systems which are generally regressive. Therefore, the subsidy would appear to be unfair, especially when the country's resources are inadequate to satisfy the more essential needs of the population. The same criticism cannot be raised against payments by the government as employer and for interest, both of which are rather necessary expenditures, due by the government for services received.43

DO PAYROLL TAXES SUBSTITUTE FOR OTHER TAXES OR ADD TO THEM? What are the economic, social, and political determinants of the absolute and relative size of social security taxes in the tax structure of various countries? This question can be posed for every tax. The answer is important for defining the tax policy of a country in a certain stage of development, when the objective is to maximize tax revenues consistent with given economic, social, and political constraints. Knowledge of the factors which influence the existence and the importance of the different taxes (including the existing tax structure) allows the policymaker to exploit the tax system in the most feasible way. Among these factors, we have considered the number and type of social risks covered, the coverage of the programs (generally limited

43 See Reviglio, op. cit.f p. 336.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 533 because of the large agricultural sector and small monetary sector), and the lack of adequate medical and administrative facilities outside the large cities. Another determinant is the size of financial resources which can be channeled to social security. These resources depend, above all, on the amount and distribution of income and on the amount and kind of other taxes collected by the government. Social security tax revenues are generally a sizable part of total taxes in developing and developed countries. Table 12 presents for 55 coun-

TABLE 12. SOCIAL SECURITY TAXES: RELATION TO TOTAL TAX REVENUES, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, GROUPED ACCORDING TO PER CAPITA INCOME, RECENT YEAR (Taxes in millions of national currency; per capita income in U.S. dollars)

Social Security Taxes As a per cent of Central government Total Per Capita Income tax tax Group Year Amount revenue * revenue

Under $150 Tanzania 1961/62 0.1 0.6 0.5 Burma 1962/63 7.8 0.7 0.62 Nigeria 1962/63 1.0 1.0 0.8 2 Malagasy Republic 1962 700.0 3.8 2.8 Upper Volta 1963 239.3 3.9 Mali 1962 388.9 4.5 Mauritania 1962 134.4 5.6 Ceylon 1961/62 71.0 5.6 5.22 India 1960/61 889.0 6.6 5.9 Philippines 1961/62 82.2 6.7 5.8 Dahomey 1962 352.3 9.6 $150 up to $300 Ghana 1960/61 0.3 0.5 Iraq 1962/63 0.7 0.7 0.6 China, Republic of 1960/61 136.0 2.4 1.2 Senegal 1962/63 1,096.0 3.2 Honduras 1964 2.6 3.2 El Salvador 1963 6.0 3.6 Congo (Brazzaville) 1963 633.3 6.2 Dominican Republic 1962 7.8 6.4 5.8 Malaysia 1961 90.0 9.4 Nicaragua 1963/64 32.5 9.6 8.3 Turkey 1963/64 1,001.0 11.2 9.6 Paraguay 1962 679.0 17.1 14.1 Peru 1963 1,604.0 21.0 12.6 Ecuador 1963 462.0 24.3 16.8 United Arab Republic 1963/64 68.6 24.9 17.4 Brazil 1961 96,700.0 33.8 15.3

©International Monetary Fund. Not for Redistribution 534 INTERNATIONAL MONETARY FUND STAFF PAPERS TABLE 12 (concluded). SOCIAL SECURITY TAXES: RELATION TO TOTAL TAX REVENUES, SELECTED DEVELOPED AND DEVELOPING COUNTRIES, GROUPED ACCORDING TO PER CAPITA INCOME, RECENT YEAR (Taxes in millions of national currency; per capita income in U.S. dollars)

Social Security Taxes As a per cent of Central government Total Per Capita Income tax tax Group Year Amount revenuex revenue

$300 up to $700 South Africa 1962/63 12.9 1.8 1.4 Lebanon 1963 6.6 2.1 2.2 Colombia 1963 258.0 8.9 5.6 Guatemala 1964 9.9 11.7 Costa Rica 1962 56.8 15.6 12.7 Mexico 1963 2,801.0 20.9 14.4 Israel 1960/61 209.0 22.7 17.0 Panama 1963 12.0 22.9 18.0 Portugal 1962 3,232.0 30.5 21.4 Chile 1963 520.03 40.5 27.6 Greece 1962 6,354.0 41.6 25.7 Argentina 1962/63 64,000.0 49.8 22.4 Uruguay 1963 2,139.0* 92.8 44.6 $700 and over Venezuela 1962 191.1 3.4 Ireland 1962 11.2 8.4 6.6 Iceland 1962 244.0 11.2 7.8 Canada 1962 812.0 14.3 7.7 United Kingdom 1962 1,197.0 18.1 14.0 Sweden 1962 3,605.0 20.8 13.6 Norway 1962 2,485.0 25.9 19.0 United States 1962 23,994.0 27.9 15.3 Belgium 1962 42,100.0 33.8 24.1 Netherlands 1962 4,012.0 37.5 26.8 Austria 1962 13,070.0 38.8 20.7 Italy 1962 2,467,000.0 56.0 33.3 Switzerland 1962 2,135.0 57.2 22.1 France 1962 45,130.0 66.6 35.8 Germany 1962 34,910.0 73.0 27.9

Sources: Mainly from Reviglio, op. cit., Appendix, and Organization for Eco- nomic Cooperation and Development, National Accounts Statistics, 1955/1964, 1966. 1 Excludes social security. 2 Excludes municipal taxes which are not available. 3 Eleven agencies only (about 80 per cent of the total). 4 Includes some returns on investment.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 535 tries, ranked according to per capita income (in U.S. dollars), the importance of social security taxes relative to (1) central government tax revenue excluding social security taxes and (2) total tax revenue for those countries for which the data are available. Such taxes ranged from as low as 0.5-0.6 per cent of all other central government tax revenue (Tanzania and Ghana) to 73.0 per cent (Germany) and to 92.8 per cent (Uruguay). They represented as little as 0.5-0.6 per cent of total government tax revenues (Tanzania and Iraq), and as much as 35.8 per cent (France) and 44.6 per cent (Uruguay). The distribution in the ratios between social security taxes (5ST) and central government tax revenues (CGTR) indicates that the ratio increases with an increase in per capita income—i.e., gross national product (Y) divided by population (ΛΟ—up to a certain level of income and thereafter it declines. Using a parabolic function, it has been found that per capita income explains 35 per cent of the variation in the ratio of social security taxes to central government tax revenue, based on a sample of 64 countries (the 55 countries in Table 12 plus Chad. Ethi- opia, Haiti, Kenya, Korea, the Sudan, Thailand, and Uganda—all with per capita incomes of less than US$150—and Jamaica in the income group of $300 up to $700). The following equation was obtained:

Both coefficients for the standard error are statistically significant. The importance of social security taxes in relation to central government tax revenue is influenced by other variables besides per capita income. However, an explanation for the influence of per capita income could be this: beyond a certain level of per capita income, when the coverage of social security programs becomes more general, payroll financing gives way to general budget financing. Most developing countries, however, are in the stage in which the ratio of social security taxes to central government taxes tends to increase with increase in per capita income.44

4 SST Y * A linear relationship between CGTR and -^ does not explain as much of the variations as a parabolic function does. In fact, for the 64 countries, the following linear equation was obtained:

and for the 49 countries with per capita income of less than US$700:

©International Monetary Fund. Not for Redistribution 536 INTERNATIONAL MONETARY FUND STAFF PAPERS We have, then, tried to answer the question whether social security taxes represent a net addition to tax revenues or whether they displace other sources of tax revenue. It is of interest to know how the imposition of social security taxes affects a country's ability to levy other taxes to finance general expenditures. If it can be shown that social security taxes, in general, are not offset by lower tax revenue from other sources, they may generally be depended on to result in a net increase in a country's revenues. This would constitute indirect evidence for the hypothesis which is discussed in a previous paper,45 that contributors do not consider social security contributions in the same way as other taxes, because they regard the payments as an insurance premium which is capitalized for the future. The following equations were run with empirical specifications for 58 countries: 4β

(2)

(3) where CGDT represents central government direct taxes. Per capita income was employed as an independent variable in order to isolate one of the main causes of variation in government revenue. In spite of the not quite satisfactory level of significance, the findings might suggest that central government tax revenues (exclusive of social security taxes) were not, in general, impaired by taxes earmarked for social security purposes.47 The positive coefficient for per capita social

The ratio of social security taxes to central government tax revenue, for the countries with per capita income of US$700 or less, appears to increase an average of six points for every $100 of increase in per capita income. But per capita income explains only 25 per cent of the variation in the ratio of social security taxes to central government tax revenue. 45 Reviglio, op. cit., p. 345. 46 The 55 countries included in Table 12 plus Chad, Ethiopia, Haiti, Jamaica, Kenya, Korea, the Sudan, Thailand, and Uganda minus Congo (Brazzaville), Mali, Mauritania, Senegal, Upper Volta, and Venezuela. 47 The equation is

where the coefficients for social security taxés and income per capita are significant at the 80 per cent and 99 per cent level, respectively.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 537 security taxes (0.33) indicates that social security taxes and government revenues are both correlated with other factors not included in the equation. However, the large standard error (0.218) indicates a wide variation; therefore, the likelihood that social security taxes do impair the ability of some countries to finance general fund expenditures should not be excluded, especially where payroll and other social security taxes are high. Although the unsatisfactory level of significance does not permit to consider the statistical test favorable to the hypothesis that social security taxes are a substitute for direct taxes 48 and a complement for indirect taxes,49 it is not inconsistent with it. The statistical relationship between social security taxes and indirect taxes suggests that high social security taxes are generally accompanied by relatively low direct taxes and high indirect taxes. This does not mean, however, that it would be illogical for the fiscal authorities to raise the level of indirect taxes without at the same time raising social security taxes. 48 The equation is

where the coefficients for social security taxes and income per capita are significant at the 80 per cent and 99 per cent level, respectively.

49 The statistical result is where the coefficients for social security taxes and income per capita are significant at the 95 per cent level and 99 per cent level, respectively. #2 — 0.35.

Le secteur de la sécurité sociale et son financement dans les pays en voie de développement

Résumé Le présent article examine l'importance croissante du secteur de la sécurité sociale dans les pays en voie de développement, et les effets des diverses méthodes utilisées pour la financer. Dans les nombreux pays en voie de développement considérés, en moyenne, un dixième environ de la population (personnes à charge comprises) est couverte par un programme de sécurité sociale. Ces der-

©International Monetary Fund. Not for Redistribution 538 INTERNATIONAL MONETARY FUND STAFF PAPERS nières années, les recettes de la sécurité sociale ont dépassé 1,9 pour cent du produit national brut dans seize pays en voie de développement, s'échelonnant jusqu'à 12,6 pour cent, ce qui est comparable au niveau le plus élevé dans les pays développés. Les dépenses de la sécurité sociale dans vingt-deux pays en voie de développement étudiés sont en général inférieures à ses recettes, et représentent de 0,4 à 42,0 pour cent des dépenses courantes de l'Etat, dépassant 10 pour cent dans treize pays. Dans dix-neuf pays développés, l'éventail va de 16,5 à 52,7 pour cent. La méthode de financement adoptée dans la plupart des pays en voie de développement est la cotisation sociale versée conjointement par les employeurs et les salariés. Très peu utilisent complètement la méthode "sociale" (c'est-à-dire le financement direct de l'Etat) qui ne semble pas équitable lorsque les programmes assurent seulement les salariés de l'industrie et les fonctionnaires, et que les impôts sont régressifs. Les versements de l'Etat provenant de son budget général (y compris sa contribution en tant qu'employeur) ont représenté plus de 29 pour cent des recettes de la sécurité sociale dans la moitié des trente et un pays en voie de développement considérés, et plus de 46 pour cent dans un sixième de ces pays. Ces versements ont représenté en moyenne plus de 5 pour cent des dépenses courantes de l'Etat dans neuf pays, et se sont échelonnés jusqu'à 16,6 pour cent. En raison des déficits budgétaires et de l'inflation, plusieurs gouvernements, surtout en Amérique latine, n'ont pas pu effectuer tous leurs versements au titre de la sécurité sociale. Les cotisations ont représenté de 4,0 à 48,8 pour cent du salaire et ont dépassé 12 pour cent dans la moitié des pays considérés. Des cotisations trop élevées risquent de n'être point perçues, surtout en période d'inflation, tandis que des cotisations raisonnables, supérieures aux prestations, peuvent contribuer à endiguer l'inflation. Bien que l'on ait critiqué leur caractère régressif, les cotisations sociales sont politique- ment réalisables, élastiques par rapport au revenu, et faciles à recouvrer. Il ne semble pas qu'elles excluent le recouvrement d'autres impôts. Alors que leur importance dans le système fiscal des pays en voie de développe- ment semble s'accroître en fonction du revenu par habitant, la corréla- tion statistique qui existe entre ces prélèvements et les impôts indirects paraît indiquer que des prélèvements élevés s'accompagnent en général d'impôts directs relativement faibles et d'impôts indirects relativement élevés.

©International Monetary Fund. Not for Redistribution SOCIAL SECURITY FINANCING IN DEVELOPING COUNTRIES 539 El sector del seguro social y su financiamiento en los países en desarrollo

Resumen Este trabajo examina la creciente importancia del sector del seguro social en las economías en desarrollo así como el efecto de diversas modalidades de financiamiento de dicho seguro. En los muchos países en desarrollo comprendidos en el estudio, el número de personas amparadas por algún programa de seguro social constituye como promedio aproximadamente la décima parte de la población (contando a los miembros de familia dependientes). Las recaudaciones recientes por concepto de seguro social sobrepasaron del 1,9 por ciento del producto nacional bruto en 16 países en desarrollo y llegaron a ser hasta del 12,6 por ciento, proporción que se asemeja a la mayor alcanzada en países desarrollados. En 22 de los países en desarrollo estudiados, el monto total de los pagos a beneficiarios del seguro social, que generalmente es menor que las recaudaciones, repre- sentó desde un 0,4 por ciento hasta el 42,0 por ciento de los gastos públicos corrientes, y en 13 de ellos excedieron del 10 por ciento. En 19 países desarrollados esos pagos representaron desde un 16,5 hasta un 52,7 por ciento. La mayoría de los países en desarrollo han adoptado como fuentes de recursos para el seguro social, o bien un fondo de previsión social o bien un sistema de seguro con prima a base de una contribución obliga- toria a cargo de los trabajadores y de los patronos calculada de acuerdo con la nómina de sueldos y salarios. Pocos emplean totalmente el denominado método "social" (de financiamiento directo por el go- bierno), el cual no parece equitativo si se trata de programas limitados (que comprenden solamente a trabajadores industriales y empleados públicos) y de sistemas de impuestos regresivos. En la mitad de 31 países en desarrollo los pagos por concepto de seguro social efectuados por los gobiernos con fondos provenientes de sus rentas generales (incluso las aportaciones del Estado en calidad de patrono) sobrepasaron del 29 por ciento de las recaudaciones por concepto de seguro social, y en una sexta parte de tales países sobrepasaron del 46 por ciento. En 9 países el promedio de esos pagos fue de más del 5 por ciento de los gastos públicos ordinarios, habiendo llegado hasta el 16,6 por ciento. A consecuencia de los déficit presupuestarios y de la inflación, varios gobiernos, principalmente de la América Latina, han incurrido en mora en sus pagos por seguro social. La contribución sobre sueldos y jornales fue de entre un 4,0 y un 48,8 por ciento de los mismos, y en la mitad de los países representó

©International Monetary Fund. Not for Redistribution 540 INTERNATIONAL MONETARY FUND STAFF PAPERS más del 12 por ciento. Imponer una contribución elevada puede oca- sionar morosidad, especialmente en períodos de inflación, pero una contribución razonable que sea mayor que los pagos puede ayudar a contener la inflación. Aunque se la tache de regresiva, la contribución sobre los sueldos y jornales es factible desde el punto de vista político, priva en ella la elasticidad-ingreso, y es de fácil recaudación. No hay prueba de que dicha contribución obste para la imposición de otros impuestos. En tanto que la importancia relativa de las contribuciones de esa índole en la estructura tributaria de los países desarrollados parece aumentar a medida que el ingreso por habitante, la correlación esta- dística entre la contribución al seguro social y los impuestos indirectos sugiere que cuando aquélla es alta suele ir acompañada de impuestos directos relativamente bajos y de impuestos indirectos elevados.