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