The turning point: the reforms of the 1990s

3) The turning point: The reforms of the 1990s

Until the early 1990s the structure of the pension system had survived practically unchanged for over twenty years, and only small “ameliorations” were undertaken. A short period of reforms begun under the Ciampi government in 1992 with the Amato reform and was continued in 1995 by the Dini government. Franco (2000) individuates three main “factors” underlying the need for reforms: “the increase in projected outlays, the adverse effects of the pension system on the labor market, and its widespread distributive anomalies and inequities”. However, it was obvious in 1992, the year in which Italy faced a severe financial crisis that led to a strong devaluation of the lira and to following abandonment of SME, the main concern would have been the financial sustainability of the system itself. In fact, even though alarming prospects had been outlined by researchers already in the late 1970s, and then throughout the 1980s, it was only in late 1991 that official reports from INPS and the Treasury Minister depicted an alarming situation, suggesting the need for a switch from the optimistic view of the system from the time of its inauguration to a more realistic one. Both the 1992 and 1995 reforms must be considered in the context of this new state of mind of Italian politics, which from this time has been characterized by a short -term approach, thus making any attempt of reform with a long-term aim practically impossible to pass in parliament.

This is the main reason for the difficulty in undertaking a major reform of the Italian welfare system. The Ciampi government, which was responsible for starting the process, was a technical government (governo tecnico) that faced a very serious financial situation. Since then the various governments have adopted short-sighted policies, delaying the approval of structural reforms needed by the country. Not surprisingly, the major provisions touched by the reforms regarded pensions and health care. The pension system that emerged in the early 1990s was profoundly different from the preceding one. As Banetti (2002) stresses, it was now “more sustainable from a financial point of view and characterized by greater equity among workers”.

The expected implementation of a “second pillar” (occupational funds), traditionally underdeveloped in Italy, was intended. However, it was not fully successful and, as a result, almost fifteen years later is still the topic of heated debates. In fact, even though the current Prodi government has in its agenda the goal of shortening the transition period when a second funded pillar, first financed by severance pay, should consistently be introduced into the system, strong opposition from both employers and trade unions could once again lead to a delay. A second funded pillar has struggled to become an effective consumption-smoothing instrument, as Ferrera (1998) points out, mainly because of the very generous provisions of the first pillar and the rules regarding the end of career payments, which have consequently reduced the appeal of supplementary funds.

a) The 1992 Amato reform

“…after years of sterile discussions the Italian Parliament finally approved the much awaited and much needed pension reform and the “reform of the health reform”, thus making a significant breakthrough on the road towards a new model of welfare” (Ferrera, 1998). The principal aim of this intervention was to tackle the huge imbalances reached by public finances in order to reduce pension expenditures as a fraction of GDP. Franco (2001) suggests that the maneuver actually cancelled about 25% of the pension liabilities, cutting pensions both in the immediate (no more pension indexation to real wages) and in the long term (gradual abolition of the privileges granted to public employees). Therefore, this explains how the government was able to pass a bill that, differently from the past, had a long-run perspective. The main changes introduced into the pension system were essentially the following:

a.       raising the retirement age from 55 to 60 for females and from 60 to 65 for males working in the private sector, thus tightening the eligibility criteria for retirement;

b.      gradually raising the minimum contribution requirement for old age benefits from 15 to 20 years;

c.       increasing the reference period for calculating pensionable earnings from the last 5 years to the last 10 years. For those workers with less than 15 years of contributions and for new entrants into the labor market the reference period was instead extended to the whole working career;

d.      gradually raising the contribution requirement for seniority (early retirement) pensions to 35 years for all workers. This measure intended to reduce the privilege granted to public workers, who were eligible for seniority pensions with only 20 years of contributions, by equalizing the criteria to those required from private sector workers;

e.       increasing contribution rates to 33%;

f.        benefits were no longer indexed to real wages.

Baldini, Mazzaferro and Onofri (2002) point out that the reform had a major effect on the perception of households, mostly on those where the breadwinner was employed in the public sector. In fact, the 1992 reform demonstrated for the first time to these workers that the level of wealth they had expected to receive from the social security system during their lifetime was no longer sustainable.

b) The 1995 Dini reform

The main feature of what is known as the Dini reform, which changed the institutional design more profoundly, was the shift towards a system characterized by the accumulation of contributions into a notional social security account, still held by INPS, transformed once the worker retired into an annuity. In fact, while the 1992 reform aimed at cutting pension expenditures, the 1995 reform while still continuing to focus on this objective was meant to reduce distortions in the labor market and make the system fairer. Making pensions benefits more closely related to individual contributions was thus fundamental in order to achieve both objectives. The belief behind this measure was that contributions would be better perceived as a deferral of earnings, thus reducing the distortionary effect of labor income taxation (Franco 2001). Often in a PAYG system payroll taxes are perceived as an effective tax, because the link between marginal retirement saving and marginal retirement income is very loose.The main points of this reform were the following:the annuity received by pensioners would now be related on one hand to lifetime contributions and on the other to retirement age. This was achieved by shifting from an old earnings-related formula to a new contribution-related one and by introducing a flexible retirement age (57-65). Annuities were calculated on an actuarial base, discounting by conversion coefficients specifically related to both life expectancy and retirement age;

1. the introduction of an age threshold for seniority pensions (57 years) for all workers,  with the prospect of  abolishing them completely in the future;
2. the standardization of rules for public and private employees;
3. the income testing of survivor benefits;
4. stricter rules on the cumulability of disability benefits and income from work, as well as tighter controls on beneficiaries.

The measures undertaken implemented the harmonization process started with the Amato reform in 1992. This was achieved by calculating new pension benefits on all the years of activity in the labor market not longer on the last years of a career, thus removing a privilege previously granted to those workers with dynamic careers and then by equalizing the rate of returns of early and late retirees. As a consequence, in the current public pension scheme the mean rate of substitution between pensions and salaries decreased by almost a third. Over the years the trend toward promotion just before retirement had emerged as problematic. It obviously put further pressure on the sustainability of the system since social security outlays in this case did not reflect the actual contributions paid by individuals throughout their working life.