Pension Reform and Long-Run Fiscal Policy in Norway. Professor Kjetil Storesletten

Transcription

1 Pension Reform and Long-Run Fiscal Policy in Norway Professor Kjetil Storesletten

2 Norway anno 1995 Well-functioning labor mkt.: high employment, men & women Oil was discovered offshore Norway 7 years ago (19) Large oil extraction ahead (peak during ) : oil revenue had been spent as it arrived 19-9: oil price crash caused spending contraction, contributed to banking crisis Challenges: 1. With historically volatile oil price, the prospect of «spend as you go» seemed daunting. Political pressure to spend, spend, spend 3. Generous and underfunded pension system with weak work incentives (especially after age ). Generous disability pension and rising disability rates 5. Inefficient and highly subsidized agricultural sector

3 Oil revenue and fiscal deficit, 197- Oil taxes and structural fiscal deficit in percent of GDP mainland Norway 5 Statens netto kontantstrøm 5 15 Strukturelt underskudd

4 Ageing is challenge to fiscal sustainability Net spending per age group in 1 1 NOK Dependency ratio Ratio of number of retirees (7+) to number of people age. Percent Norge EU

5 Politicians aimed at four reforms: 1. Plan for long-term fiscal policy to phase in the oil revenue in a sensible way («Handlingsregelen»). Done by 1. Pension reform. Done by 9 3. Disability reform: not done yet. Agricultural reform: not done yet 5

6 Fiscal Rule was motivated by many concerns: Phase in the oil revenue gradually (avoid Keynesian «overheating» and waste in government spending) Avoid «Dutch Desease» (first contraction in tradeable sector, then need for rapid expansion when oil is over) Gradual and smooth development in government spending and services Smooth taxes Shield government budget for oil price fluctuations Share oil wealth between generations Rule should be simple to communicate

7 Fiscal Rule: made to handle large revenues from oil and gas Return on investments Revenues Petroleum revenues Fund (invested abroad) Transfer to finance non-oil budget deficit State Budget Fiscal policy guideline Expenditures consumption investment 7 7

8 Fiscal Rule: Separate oil revenue and spending Put all tax revenue from oil into the Oil Fund Let a fixed fraction (%) of the Oil Fund be added to the regular fiscal budget every year Allow for business cycle adjustments (spend more during recess.) No additional government borrowing Invest % in stocks and % in bonds and real estate, in global portfolio, except Norway In, a return of % annually seemed reasonable (%=.*.5%+.*5%) With % return and % take-out, once all oil is extracted the fund will remain constant Each future goverment can spend the same NOK amount Delivers some intergenerational fairness Note: no targeting of future spending (each govt. will choose)

9 Successful in separating spending and oil revenue Fiscal Deficit, Petroleum income and expected real return on Oil Fund Percent of trend-gdp mainland Norway Statens netto kontantstrøm Strukturelt underskudd Forventet fondsavkastning

10 Fund versus remaining oil in ground Wait, Fund is growing as more oil is extracted - Why spend % of the FUND, as opposed to % of FUND + REMAINING OIL? («spend more») Population is ageing, why not delay spending? («spend less») Motivation for simplistic % rule: Spending % of Oil Fund was expected to yield a spending which would grow as a share of GDP until 5. This would roughly coincide with the expected ageing of the population. Simple rule, ok compromise How could politicians agree on a long-term plan of spending? (all but one party supported the agreement) Lots of money to spend (no difficult trade-offs), money will come over next 3 years, no targeting of future spending 1

11 Expected take-out in 1 and realized 1-15 Fiscal Deficit, Petroleum income and expected real return on Oil Fund Percent of trend-gdp mainland Norway Strukturelt underskudd St.meld. nr

12 Ageing will challenge public coffers Expected take-out from Oil fund and disability + oldage pension expenditures Percent of trend-gdp mainland Norway Strukturelt underskudd Forventet fondsavkastning ( pst.) Alders- og uførepensjon i Folketrygden Kilde: Finansdepartementet 1

13 New challenges anno 15 Large recent shocks to rate of return on fund. With a big fund, rate of return shocks have large effect Hard to predict future: Large recent immigration wage (% of work force is now immigrants) has delayed ageing, but retirement wave will eventually come Current low rate of return on bonds bode lower expected returns for 1- years to come Current % rule implies «spending peak» occurs before «needs» Fund is small relative to future tax revenue: Fund+ remaining oli revenue = times GDP. NPV of future tax revenue = 5 times GDP (with g=1%, r=3%) Norway cannot ignore reforms of welfare state - strengthening work incentives (pension, disability reform) - Health care costs unchecked (Norway has world s largest spending on health care, after USA and Switzerland) 13

14 Challenge 1: Changing outlook for fiscal policy Expected real return on Oil Fund and structural fiscal deficit Percent of trend-gdp mainland Norway Nasjonalbudsjettet 5 Nasjonalbudsjettet Strukturelt underskudd %-banen Strukturelt underskudd %-banen Nasjonalbudsjettet 1 Nasjonalbudsjettet Strukturelt underskudd %-banen Strukturelt underskudd %-banen

15 Lower expected return on the Oil Fund 1 Lower expected return on fund the next 15 years, then %. Percent of trend-gdp mainland Norway Strukturelt underskudd %-banen 3 pst. pst. 1 pst

16 Risky return on Oil Fund and future oil price risk 1

17 The peak of oil revenue spending has come closer Fiscal Deficit, Petroleum income and expected real return on Oil Fund Percent of trend-gdp mainland Norway Strukturelt underskudd % avkastning % avkastning neste 15 år St.meld. nr

18 and might be behind us when ageing accelerates Forventet realavkastning av SPU og strukturelt, oljekorrigert underskudd Prosent av trend-bnp for Fastlands-Norge Strukturelt underskudd % avkastning % avkastning neste 15 år Demografiforløp for strukturelt underskudd St.meld. nr

19 Recommendation 1: When deviations from % rule, government should indicate multi-year plan to return to %-path The Fiscal Rule has been applied with flexibility during 1-15 (Ministry of Finance has had authority in indicating a «sensible» business-cycle-adjusted deviation) But this will be more challenging when deviations from %-rule become large The government should provide explicit multi-year plan for how to return to % rule (in line with overall aims of Fiscal Rule) 19

20 Remcommendation : Oil revenue should be phased in more slowly Little room for further long-run expansion If fast expansion now, then need for reduced spending in 5-1 years Harder to expand than reduce spending Large undertainty but ageing will come 1 1 Fiscal Deficit, Petroleum income and expected real return on Oil Fund Percent of trend-gdp mainland Norway Strukturelt underskudd % avkastning % avkastning neste 15 år St.meld. nr

21 Implementation of (): reduce take-out from % to 3% over the next years 1 Fiscal Deficit, Petroleum income and expected real return on Oil Fund Percent of trend-gdp mainland Norway Strukturelt underskudd -prosentbanen -15 % uttak fra fondet Uttak følger demografiutgifter og deretter 3% av fondet Demografiforløp for strukturelt underskudd

22 Recommendation 3: return to %-rule gradually Fiscal Deficit, Petroleum income and expected real return on Oil Fund Percent of trend-gdp mainland Norway Strukturelt underskudd %-banen -15 Rask innfasing (budsjettimpuls,5) Gradvis innfasing (budsjettimpuls,1) 1 3 5

23 Pension reform: old system o o o No clear link between pension contributions and benefits Strong incentives to retire early (sharply falling retirement age 199-5) Generous and unsustainable pension system (especially with increases in longevity) 3

24 Pension reform: new system Explicit link between constributions and future benefits: pension taxes contribute to «pension wealth» o 1.1% pension tax o All years count, & all earnings between 1 and 3 NOK Pension wealth(t+1) = (1+g(t))*P.wealth(t) + 1.1%*Earnings(t) «Notional individual accounts», return = growth rate in earnings Benefits are adjusted by expected longevity at retirement => When a cohort is expected to live longer, benefits fall Example: if a person retires at age 5, and expected remaining longevity is years, monthly pension will be Monthly Pension = Pension wealth / (*1) Flexible retirement age, possible to simultaneously receive pensions and work, without any «penalty»

25 Pension reform (cont.) Reform will be phased in gradually (generations in transition get mixture of old and new pension beenfits) But flexible retirement and longevity adjustment applies to all Trade-off «fairness» versus «econonmic efficiency» o Stronger incentives to work will imply less benefits to some o «Sugar the pill»: some non-work activities qualify for retirement benefits (military, staying home with children) o People on disability pension have been shielded from ageadjustment (so huge incentive to become disabled before ret.) Reform seems to have had huge effect on labor supply: o Employment rate for -years old: +1% (a 5% increase) o Best case: (Galaasen, 15): +9% increase in aggr. labor supply Challenge: pension reform is not yet compatible with pension system for government employees 5

26 Conclusion The upshot for Norway: o o o Large and temporary petroleum revenues have forced Norway to formulate explicit fiscal policy goals for the long run Good funding has made it easier to agree on pension reform But lax fiscal policy has tempted politicians to ignore other reforms which are both needed and painful o Reform of agricultural sector o Reform of disability and sickness pension systems What s in it for Denmark? Denmark is almost in the same situation as Norway o o The loin s share of government wealth is NPV of future taxes Rapidly ageing population Time to formulate an explicit long-run fiscal policy framework