M-RCBG Senior Fellow-Led Study Group: Ioana Petrescu
Eating the Seed Corn: What Romanian private pensions can teach us about populism and lack of transparency
September 27, 2:00 – 3:30, M-RCBG Conference Room, B-503
One of the most important rules in investing is: “Don’t eat your seed corn!”, that is, do not spend all your money today and make sure to invest enough in your future. In 2017, the Romanian government broke this very rule by passing a law that took tax money meant for investment in future pensions and used it to pay current pensions. This measure not only reduced future pensions for young people, but also put the whole Romanian pension system at risk.
The Romanian public pension system is PAY AS YOU GO, which means that workers pay social security taxes and this money goes directly to current retirees. However, due to demographic decline, migration of labor force out of Romania and high evasion of labor taxes, the public pension system became unsustainable. Realizing that it cannot rely on public pensions alone, 11 years ago, government added private pensions into the mix by introducing mandatory private pension accounts for young people. Under this new system, only a part of social security taxes goes to current retirees. Another part now goes into private accounts owned by the individual taxpayers, where money is invested in safe assets. The money from these private pension accounts can be withdrawn by the owner upon retirement, or by heirs upon the death of the owner.
In 2017, the government faced high public expenditures and a large deficit of the public pension budget. The officials reduced the share of social security taxes that goes into the private pension accounts in order to use this tax money to pay current pensions. They also allowed people to move money from the private pension accounts to public pensions. These policies led implicitly to a reduction in future pensions and to a destabilization the entire pension system by making it too reliant on public pensions.
In this Study Group session, we will discuss how politicians’ populism and lack of transparency around the private pension accounts created an opportunity for the government to pass such a harmful measure with little voter backlash. We will also analyze how behavioral economics played a role in saving private pensions in Romania.
Ioana Petrescu is a Senior Fellow at the Mossavar-Rahmani Center for Business and Government and a Visiting Research Fellow at the Ash Center at the Harvard Kennedy School. Dr. Petrescu is a former Romanian Finance Minister. While minister, she pursued policies to cut tax evasion and tax avoidance, promote financial transparency, improve tax compliance, lower the tax burden for businesses and keep fiscal discipline. She also served in the government as an economic adviser to the prime minister and head of his delivery unit, where she monitored the implementation of the prime minister’s priorities in procurement, employment, energy and tax compliance. She is an international consultant on issues such as tax reform, central government delivery and local public services and runs the Center for Leadership and Innovation at the National School of Political Science and Public Administration in Bucharest. In the past, she also served as an expert for the European Economic and Social Committee in Brussels. She was an Assistant Professor at University of Maryland and she holds a Ph.D. in economics from Harvard. She published in various academic journals and newspapers. Her 2017 book, Essays in Taxation and International Relations, analyzes issues such as flat taxation and government revenues. Ioana’s research project, Democracy and Delivery: The Devil is in the Details, explores good practices in the delivery of public goods and services in new democracies characterized by corruption and clientelism, low paid bureaucrats, poor institutions, frequent political turnover, unclear legislation, and little transparency. Her faculty sponsor is Jeffrey Frankel, James W. Harpel Professor of Capital Formation and Growth at Harvard Kennedy School. Email: firstname.lastname@example.org