Costa Rica

Costa Rica is entering a demographic transition which will see the old age dependency ratios significantly worsen in the coming 20 years.Public pension spending and other government spending determined by demographics -including health care -will exert growing pressure on public finances.The working age population -contracting both as share of the total population and in terms of its numberwill only be able to keep the economy growing if labor productivity compensates for demographic changes.The basic indicators of the labor market and pension system are favorable in regional comparison.The labor force participation rate and employment formality are relatively high at 60 and 72 percent, respectively.Public pension schemes operate with reserves and both the pension system's structure and its operating parameters are largely in line with best practice.While pension eligibility is far from universal, elderly poverty is low.Among the elderly, 27 percent fall below the poverty line, with 47 percent of them not receiving any form of pension (whether social or contributory), while this percentage rises to 71 percent among the non-poor elderly.the pension coverage gap and old age poverty are different problems, demanding different solutions.The long-term financial sustainability of the general social security pension scheme (IVM) is a concern.As a result of various reforms over the past three decades IVM's financial sustainability has tangibly improved.However, despite these efforts, the scheme's reserves will be exhausted by the mid-2030s.Beyond this point, the scheme will become fully pay-as-you-go financed, requiring continuous budget subsidies or parametric changes.The proposal intends to address the above problems (financial sustainability, adequate coverage, distributional equity) through the introduction of a universal basic pension (Pensión Básica Universal -PBU).PBU would be a fully funded (pre-funded) flat benefit conditioned on age and residence.The proposal's very gradual introduction is driven by the government's intention to make PBU fully funded and to build up sufficient reserves before the program's full roll-out.The proposed PBU, in its current form, is unlikely to fully meet its stated objectives.The proposal will worsen social security pension scheme's (Invalidez, Vejez y Muerte -IVM) financial sustainability and create additional financing needs.This will translate into an accelerated exhaustion of IVM reserves and, after the reserves are depleted, require significant adjustments to IVM parameters or higher government transfers.The latter will imply public expenditure cuts in areas other than pensions, higher taxes or additional public debt.Furthermore, the proposal will only address old age poverty and, due to PBU's universality, at the cost of transfers to upper income deciles which will be even higher than today.Old age income security may be more effectively addressed, with less pronounced fiscal sideeffects, through improving coverage and compliance in IVM and expanding the reach of the social pension scheme.The pension coverage gap is, to a large extent, driven by eligibility rules, the insufficient financing of the social pension, and ineffective revenue administration practices.Options to ©International Monetary Fund.Not for Redistribution IMF Technical Assistance Report | 9 close the coverage gap include improving revenue administration by leveraging the excellent information technology and public administration infrastructure, revising to social pension eligibility rules, and properly adjusting social transfer programs' budget allocations to social policy objectives, so that eligible applicants (including elderly people without a contributory pension) do not end up on waiting lists. Recommendations Summary of the Mission's Main RecommendationsThe mission recommends addressing coverage and old age income poverty.The primary instruments of achieving these goals are: (a) amending the rules undermining compliance with registration and wage reporting regulations in the contributory schemes, (b) improving coordination and enforcement efforts between the tax authority and the Caja, (c) amending the regulations governing eligibility for noncontributory social pensions and (d) ensuring the noncontributory social pension is adequately financed.To close the coverage gap, instead of a universal basic pension, consider measures aiming to expand coverage in the existing schemes: IVM, the social pension scheme (Régimen de Pensiones No Contributivas -RNC), and second pillar schemes: