Stop and Go in the Italian Pension Reform Process

1. The Government — Unions Agreement: An Overall Evaluation

On July 27th, 2007 the Government and the Trade Unions reached an agreement (known as the ‘welfare protocol’) which has subsequently become a law proposal, submitted to Parliament and included, as a separate bill, in the 2008 financial law. The immediate goal of the bill is to prevent the former (2004) pension law from becoming effective, as originally stipulated, at the beginning of 2008, and consequently to avoid the rather abrupt increase in retirement age (three years) established by that reform, which would cause a sharp discontinuity of treatment between adjacent cohorts (the so-called ‘scalone’ — big step — as opposed to a smooth increase in retirement age).
From a political point of view, the welfare protocol can be thought of as a ‘reasonable compromise’ between the different stances of a composite majority and the rather conservative attitudes of Italian trade unions (whose members are typically rather old).
From a technical point of view, the agreement can be evaluated according to different criteria. In this note, I will concentrate on its contribution to the financial sustainability of the system, both in the short/medium term, i.e. in the transition phase, and in the long term, i.e. when the new Notional Defined Contribution (NDC) regime will be fully phased in.
As for the medium/short term, still characterised by a defined benefit type of formula, the main change is the smoothing of the ‘scalone’. With respect to the 2004 Maroni law, the new provision stipulates a milder increase in retirement age as of 2008, followed by a phase of progressively more stringent combinations of seniority and steadily increasing minimum retirement ages. Two caveats, however, are in order: i) the still unclear definition of the categories of workers in hazardous occupations, to whom the increases will not apply; ii) the amount and coverage of the costs.
As for the long term, a positive feature of the law proposal is that it reaffirms the contribution-based method for calculating benefits. Indeed, the law stipulates new and tighter rules for the revision of the transformation coefficients (one of the key ingredients of the NDC system), which somehow strengthen the mechanism. However, contradictory signals are also given, such as the further postponement of the first revision (originally due in 2005, it is further deferred to 2010) and the reference to a possible guaranteed replacement ratio for the young generations, which could undermine the commitment to the new system.
In short, the agreement is a mix of lights and shadows, which deserve substantiation under a wider evaluation perspective.

2. Rising Retirement Age

To provide a proper assessment of the new measures, one needs to take into account the long transition of the Italian pension reform, and its differential impact on the various cohorts. A pay-as-you-go system is necessarily projected into the long term, involving all present and future generations. This feature creates asymmetries as to the effects of legislative innovations: while improving reforms usually find an immediate application, restrictions to benefits tend to be gradual, so as to soften their effects on the elderly, who can hardly offset them by saving more or working longer. The delay in application usually also involves active cohorts, so that the closer a worker is to retirement, the less (s)he will be touched by the cutback.
In Italy, the reform season started in 1992, with the Amato reform, which curtailed both the generous rules for the calculation of the earnings-based pensions and the indexation mechanism (since then applied to prices only, instead of wages). The change in the pension formula, however, only applied to the cohorts with less than 15 years of work, fully for the new generations and on a pro-rata basis for the others. This partition was reaffirmed in 1995 by the Dini reform, which introduced the contribution-based formula within the public PAYGO system.
This delay has generated a very long transition which can be characterised (approximately) as follows: until 2013-15 workers are still subject to the more generous pre-reform rules (earnings-based pensions); from 2013-15 to 2033-35 the reform is applied on a pro rata basis; from 2033-35 all new pensions will be calculated according to the contribution-based formula; from 2060 all pensions in payment will be of the DC type.
In the transition period, i.e. until 2033-35, the reform is too slow to counteract the progressive worsening of the dependency ratio and the pension expenditure/GDP ratio will continue to rise. Given the sluggishness of the new formula, the strong financial imbalances of this period have been tackled mostly by tightening the eligibility requirements for seniority pensions, and by increasing the average retirement age. Various ‘incentives’ to job prosecution have also been devised1, insufficient however to compensate for the implicit tax embodied in the seniority pensions. Although in contrast to the flexibility principle at the base of the 1995 NDC reform, restrictions to eligibility, are certainly not without justification, as they tend to reduce the ‘gift’ implied in the rather generous DB seniority benefits.
After more than a decade of such interventions, the average retirement age in Italy has risen for both men and women to levels not far from the European average (EU 15)2; a positive change, insufficient however to make up for the already occurred gains in life expectancy and above all for the prospective ones. Moreover, an important point is that increasing retirement age should not be an exogenously established procedure, decided a posteriori as a means of restoring financial sustainability, but rather a dynamic feature of the pension system, allowing both for flexible choices and for periodic self-adjustment. From this perspective, neither the 2004, nor the 2007 reform fully incorporates the flexibility principle, as well as its counterpart, i.e. the actuarial neutrality and fairness.
The 2004 reform dealt with the issue effectively but also unevenly, by introducing, starting from 2008, the abrupt increase in the retirement age (from 57 to 60 years, combined with 35 years of seniority). Although the measure was welcomed by international institutions, during the 2006 electoral campaign the current Government coalition promised, maybe somewhat incautiously, to smooth the discontinuity of treatment.
The July 2007 agreement with the social parties (later approved by the large majority of workers through a referendum) which replaces the ‘scalone’ with more gradual increases, represents the fulfilment of that promise.
Despite its greater gradualness the new law aims at the same targets us those of the 2004 reform, while the establishment of a minimum age for seniority pensions is important because it helps contain the generosity of the still valid earning-based benefits. According to the 2004 reform the requirements for an employee in 2013 would be age 61 (62 for self-employed) and 35 years of contributions; in the new law these are replaced by ‘quota 97’ (98 for self-employed), i.e. an age/seniority combination of either 61/36 (62/36) or of 62/35 (63/35). Another continuity of the law proposal with respect to the 2004 reform is that it preserved the rather anachronistic age difference between men and women as far as old age benefits are concerned: 60 for women and 65 for men. While, on the one side, this could be a measure to compensate for women’s double activities — at work and in the household — on the other side it could be to the detriment of women when their benefits will be calculated through the contribution-based formula, as they usually have shorter and more discontinuous careers and, correspondingly, lower pension benefits.
Electoral promises however are often made without much reference to their costs. When they become law, however, costs have to be estimated. For the smoothing of the scalone, costs will amount to a total of 10 billion € in the next decade. What is even more important, is who will bear them. The laws relies on a rather vague reorganization of pension institutes, or, failing the savings coming from it, on increasing payroll tax rates by 0.09 points for all workers, a measure which is inconsistent with the Government’s commitment to reduce the tax wedge on labour income. A second open issue, which could further increase the cost of the reform, concerns the definition of workers occupied in hazardous jobs, who are excluded by the reform and can access retirement at lower ages; barring the use of scientific knowledge for the definition, the possibility that Parliament might decide on an ideological basis, ending up listing a too large number of categories under this label, is not to be ruled out, resulting in further expenses being added to an already high bill.
To sum up, the evaluation of the sustainability of the Italian transition phase is a mixed one. It has to be stressed that, regrettably enough, once more, irrespective of all the rhetoric about the need to restore the generational balance, the older generations have been favoured with respect to the younger and future ones. For this reason, it is likely that the 2007 reform cannot be considered the last intervention in the transition process. Many issues, such as the definitions of the categories excluded by the reform, the differentiation between men and women, the possible increase in payroll taxes, are still open. However, even more important is the time consistency problem created by the many ad hoc measures introduced to deal with the very long transition period, which risks disconnecting the transition from its endpoint, i.e. the full application of the NDC system, and reducing the credibility of the method itself. The next section deals with how much credibility is left to the commitment to implementing the original 1995 reform.

Elsa Fornero: University of Turin and CeRP.
1 Incentives for job prosecution were included in the 2001 finance Act as well as in the 2004 pension reform.
2 According to the last available data, in 2002 the ages (source: Eurostat, Labour Force Survey, 2004) for Italy were, respectively for men, women and total: 60.2, 59.7, 59.9; the corresponding average European values were 61.0, 60.5, 60.8.

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