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### Viewing cable 06BRASILIA1151, BRAZIL'S SOCIAL SECURITY DEFICIT: THE ELEPHANT IN THE ROOM

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
06BRASILIA1151 | 2006-06-09 14:03 | 2011-07-11 00:00 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Brasilia

`

    VZCZCXRO3879
    RR RUEHRG
    DE RUEHBR #1151/01 1601403
    ZNR UUUUU ZZH
    R 091403Z JUN 06
    FM AMEMBASSY BRASILIA
    TO RUEHC/SECSTATE WASHDC 5716
    INFO RUEHRG/AMCONSUL RECIFE 4934
    RUEHRI/AMCONSUL RIO DE JANEIRO 2248
    RUEHSO/AMCONSUL SAO PAULO 7156
    RUEHAC/AMEMBASSY ASUNCION 5483
    RUEHBU/AMEMBASSY BUENOS AIRES 4072
    RUEHMN/AMEMBASSY MONTEVIDEO 6301
    RUEHSG/AMEMBASSY SANTIAGO 5563
    RUEHME/AMEMBASSY MEXICO 1982
    RUEATRS/DEPT OF TREASURY WASHINGTON DC
    RUCPDO/USDOC WASHDC
    RHEHNSC/NSC WASHDC

` `

    UNCLAS SECTION 01 OF 03 BRASILIA 001151

    SIPDIS

    SENSITIVE
    SIPDIS

    NSC FOR FEARS
    TREASURY FOR OASIA - DAS LEE, D.DOUGLASS
    STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
    USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
    USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA
    STATE PASS USAID FOR LAC

    E.O. 12958: N/A
    TAGS: EFIN ECON PGOV BR
    SUBJECT: BRAZIL'S SOCIAL SECURITY DEFICIT: THE ELEPHANT IN THE ROOM

    REF: A) BRASILIA 0961

         B) BRASILIA 0790
         C) BRASILIA 1036

    (U) This cable is sensitive but unclassified, please protect
    accordingly.

    ¶1. (SBU) Summary:  Brazilian pensioners recently have been subjected
    to a burdensome requirement to appear in person to reregister with
    the social security administration (INSS) in order to continue
    receiving their pension payments.  The requirement, problematic for
    elderly and sometimes infirm retirees, has sparked public protests
    in places but is meant to help the INSS clear the books of "phantom"
    pensioners, whose families continue collecting their INSS pensions
    even after their deaths.  The GoB has resorted to the
    re-registration, among other measures, in an attempt to address the
    growing deficit in the INSS system, which provides pensions and
    medical/disability payments to private sector employees.  The
    problems run much deeper than phantom pensioners, however, according
    to analysts with whom we have spoken.  These cited Lula's minimum
    wage hikes (to which the minimum pension level is pegged), lack of a
    minimum retirement age, generous benefits and the use of INSS
    pensions as a social program/wealth transfer mechanism as key issues
    that must be dealt with.  The problem is a growing one: the INSS
    deficit almost doubled, from 1.1% of GDP in 2002 to 1.98% of GDP in
    2005, and is expected to continue widening to 2.33% of GDP in 2006.
    Moreover, the deficit, which is financed from general revenues,
    increasingly is squeezing other federal expenditures, particularly
    public investments.  The issue will thus be a priority for whatever
    administration takes office in January 2007.  While Finance Minister
    Mantega has acknowledged to WHA A/S Shannon that the GoB understood
    it would have to reform the INSS system, he admitted that electoral
    politics make it difficult to debate the problem publicly.  End
    Summary.

    INSS Deficit Rockets Despite Previous Reforms
    ---------------------------------------------

    ¶2. (U) The deficit in Brazil's social security system, a
    pay-as-you-go scheme, is growing despite two previous reforms meant
    to address the problem.  Both of those efforts, the most recent in
    1998/1999, when the INSS deficit was about 1% of GDP, increased
    worker contributions and reduced benefits slightly.  Although the
    measures were predicted to stabilize the INSS deficit at 1% of GDP,
    its growth continued, initially slowly and then accelerating more
    recently.  The deficit reached 1.98% of GDP in 2005 and is predicted
    to grow to 2.33% of GDP in 2006.

         TABLE - INSS DEFICIT
           (Percent of GDP)

                       2002     2003    2004    2005    2006 /1
    --------           ----     ----    ----    ----    ----

    INSS
    Revenues
    (payroll tax)      5.3%     5.2%    5.3%    5.6%    5.6%

    INSS
    Expenditures       6.4%     6.9%    7.1%    7.58%   7.93%

    INSS Deficit       1.1%     1.7%    1.8%    1.98%   2.33%

    INSS Deficit
    as percent of
    federal            6.1%     9.8%   10.1%    10.3%   12.7%
    expenditures
    --------------------------------------------- ---------
    /1 - Predicted 2006 values
    -Data Source: Planning Ministry

    ¶3. (U) The deficit is due primarily to increased outlays, with which

    BRASILIA 00001151  002 OF 003

    contributions -- primarily payroll taxes on the salaries of formal
    sector employees -- have not kept pace.  (Note: the Lula
    Administration took action early in 2003 to limit the growth of the
    deficit in the public-employees pension system, but did not touch
    the broader private-sector social security system.)  The GoB has
    taken administrative actions to improve INSS management and reduce
    waste, such as the re-registration effort to remove phantom payees
    from the rolls.  It also has attempted to increase efficiency,
    including through the de facto merger of the INSS tax-collection
    wing (Receita da Previdencia) with the federal government's tax
    administration (Receita Federal), which it hopes will improve its
    tax payment enforcement efforts.  Finally, it has tightened
    requirements for payment of ballooning medical benefits, a
    significant portion of which was believed to be fraudulent.

    Problems Run Deep
    -----------------

    ¶4. (SBU) While these administrative actions have had some limited
    effect, the problems run much deeper.  UN Economist Carlos Mussi
    argued to Econoff that foremost among these is that the Lula
    administration granted substantial increases in the minimum wage,
    amounting to 13% in real terms, in 2004 and 2005.  As the minimum
    pension benefit level is constitutionally linked to the minimum
    wage, social security accounts have suffered.  Former Treasury
    Secretary Joaquim Levy published a document at the end of March --

    SIPDIS
    immediately prior to leaving the GoB to join the Inter American
    Development Bank (IDB) -- which warned that the real minimum wage
    increases of 2005 and 2006 would feed through not only to general
    government accounts, but also to the INSS deficit.  Raul Velloso, a
    prominent fiscal expert with ties to the opposition PSDB party, told
    Econoff that for every one Real increase in the minimum wage, INSS
    benefit payments (about 61% of which are paid at the minimum-wage
    level) jump by Reals 200 million (about USD 91 million).

    ¶5. (SBU) There is a significant social policy element to these
    minimum-wage pensions, most of which are paid to the "rural
    pensioners" and to many urban poor.  These workers become eligible
    for the minimum pension -- at age 65 for men or age 60 for women --
    based on need rather than past contributions to the INSS system.
    Rural pensioners, many of whom were subsistence farmers, need not
    prove that they contributed into the system at all.  Poor urban
    workers, frequently employed by informal enterprises, need only show
    occasional contributions to the system to become eligible.
    According to Velloso, were it not for paying rural pensions, the
    INSS system currently would be running a cash surplus.  This means
    that the formal sector workers' payroll taxes are partially
    subsidizing the rural pensions.

    ¶6. (SBU) While income transfer programs benefiting the elderly poor
    are a necessary part of the social safety net, Velloso made the case
    that they ought to be implemented more transparently, as a social
    program paid for directly from the central government budget, not
    through INSS payroll taxes.  The expensive rural INSS pensions
    program, however, is singled out by one academic study as the single
    government program with the greatest impact in reducing rural
    poverty in Brazil over the last decade.  Most analysts agree that
    de-linking the minimum pension benefit from the minimum wage is a
    necessary step for improving INSS finances, but note this would
    require a politically-controversial constitutional amendment.

    ¶7. (SBU) Another key structural problem is that for many
    contributors there is no minimum retirement age.  Anyone who has
    worked and contributed to the system for the minimum number of years
    (35 for men and 30 for women) can draw a pension.  It's not uncommon
    practice for many Brazilians, therefore, to retire in their
    mid-fifties on a full pension (i.e. not reduced to reflect their
    greater expected remaining lifespan as compared to workers retiring
    in their mid-sixties).  One measure of the problem this creates is
    that the "Dependency Ratio" in the INSS system (i.e. the number of
    active workers that support each pensioner), already has reached
    about 1.5, well below that of the U.S. and most European countries.
    Benefits, moreover, also are generous by comparison with
    contributions and can, in many cases, amount to 100% of the average

    BRASILIA 00001151  003 OF 003

    of a person's highest four years of earnings.

    Squeezing other Federal Expenditures
    ------------------------------------

    ¶8. (SBU) The INSS deficit is an increasing problem for GoB fiscal
    management.  A Central Bank contact explained that while there is no
    legal requirement that the GoB do so, it chooses as a matter of
    course to cover the shortfall in the INSS system out of general
    revenues.  As the INSS deficit has grown more quickly than federal
    general revenues, it increasingly has squeezed other GoB
    expenditures, mounting from 6.1% of federal expenditures in 2002 to
    a predicted 12.7% of federal expenditures in 2006.  Given the
    extensive set of constitutional earmarks and requirements for
    revenue sharing with states and municipalities (ref B), the growth
    in the INSS deficit has proven particularly difficult to accommodate
    and has been a principal factor behind the precipitous decline in
    federal investment expenditures over the same period.  Uniquely in
    the contentious fiscal policy debate in Brazil, the decline in
    federal investment, particularly infrastructure investment, has been
    unanimously lamented across the political spectrum here as a public
    policy failure.

    ¶9. (SBU) Finance Minister Mantega told visiting WHA A/S Tom Shannon
    on May 22 that the GoB understands there is a need to reform the
    social security system, but that it was not the time publicly to
    discuss the issue during the presidential campaign (ref C).  Mantega
    did not elaborate on what the GoB might do to address the deficit.
    The UN's Mussi said it would take a "courageous" candidate to openly
    call for reforming the INSS system during the campaign.  Mussi
    nevertheless argued that the new President at a minimum would need
    to obtain Congressional approval of a constitutional reform
    de-linking the minimum wage from the minimum pension level.  A
    minimum retirement age also is necessary, he argued.

    Growth of Private Pension Funds
    -------------------------------

    ¶10. (U) The INSS system's ill-health has proven a boon to the
    private pension business, which has seen tremendous growth, albeit
    from a relatively small base.  The industry has two segments,
    employer-sponsored plans funded by joint employer/employee
    contributions and open plans into which any individual can pay.
    According to the private pension industry association (ANAPP), total
    reserves (i.e. the sum of all deposits to date minus payouts) in
    open pension plans have grown from about Reals 3 billion in 1996 to
    Reals 10 billion in 2002, then jumped sharply to Reals 60 billion in
    2004 and are expected to close out 2006 at close to Reals 100
    billion (about USD 45 billion at current exchange rates, or 5% of
    GDP).  Employer sponsored plans currently amount to a further 7% of
    GDP.  The GoB in 2005 reduced the income tax rate applied to long
    term investments, a step which has helped boost private pension
    contributions.  While still relatively small in international terms,
    these private pension funds are becoming large enough to change
    Brazilian financial markets, providing longer term capital to the
    markets.

    ¶11. (SBU) Comment:  There is a general acknowledgement among the
    political class that the INSS system must be reformed in order to
    stanch the hemorrhage it causes to federal fiscal accounts.  But any
    attempts to change the system will elicit strong resistance from
    entrenched beneficiaries, many of whom view their pensions as a
    "right" they have conquered.  This fact will make INSS reform -- and
    broader fiscal/budget reform -- the "elephant in the room" of the
    2006 presidential campaign, the critical issue that all know is
    there but none will address.  Whether the new administration
    inaugurated in January 2007, regardless of whom is elected, will be
    able to muster a sufficiently strong coalition to push through
    substantive reform, remains an open question.

    CHICOLA

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