Financing, affordability and fiscal space

Issues of financing social protection, costs of individual programmes and systems, and the interface of social protection with taxation systems are widely debated. The social protection floors approach to building integrated social protection systems over time highlights the importance of increasing fiscal space, to create secure and sustainable financing over the long term (Harris, 2013).

Costs of social protection

In a recent report, the ILO estimates that ‘the cost of a full set of benefits[1] for the 57 low-income and lower middle-income countries ranges from 0.3 per cent of GDP for Mongolia to 9.8 per cent of GDP for Sierra Leone – with an average cost of 4.2 per cent of GDP’ (Ortiz et al., 2017b: xi). This compares with current average spend of 1.5% of GDP on social assistance programmes in sub-Saharan Africa and 0.9% in South Asia (World Bank, 2018b: 16). See Coverage, spend and systems.

On the basis of this analysis, the ILO concludes ‘some countries have the fiscal space to develop social protection floors’, while others will need to extend coverage and benefits gradually, combined with contributory social insurance schemes (Ortiz et al., 2017b: xi). The ILO report stresses the ‘time is ripe’ to implement nationally appropriate social protection floors, noting for example that countries such as India, the Philippines, Morocco, Jamaica and Sudan ‘are wealthier than Denmark in 1892 when it established universal social protection’ (ibid.: xii).

Policy issues on financing social protection

With the Addis Ababa Action Agenda (outcome of the 2015 Third International Conference on Financing for Development), UN member states promised to provide ‘fiscally sustainable and nationally appropriate social protection systems and measures for all, including floors, with a focus on those furthest below the poverty line and the vulnerable, persons with disabilities, indigenous persons, children, youth and other persons’ (UN, 2015: 6).

However, given the low tax base and high levels of informality in many low- and middle-income countries, as well as the significant resources required to finance social protection programmes and systems, there are significant challenges regarding raising revenues in a sustainable way. Critical policy issues include designing economically sustainable systems and harnessing ‘the important role of social contributions as a source of financing, complementing general taxation’ (ILO, 2018: 2).

Sources of funding

Social protection is funded through government, individual/households, employers, and development assistance. The ILO finds that a ‘combination of non-contributory and contributory mechanisms has proven to represent the most effective manner to extend coverage, typically by combining social insurance contributions, and general taxation for universal benefits (e.g. child or disability benefits) or means-tested social assistance… [for] vulnerable populations lacking contributory capacity’ (ILO, 2018: 8).

Government: Financing for social protection generally comes from the budget, foremost from tax revenues (IATF, 2017: 24) with some support from donors depending on the level of national resources available. Options that governments can explore to expand fiscal space for social protection are:

‘[To] increase the overall size of a country’s budget: (i) increasing tax revenues; (ii) expanding social security coverage and contributory revenues; (iii) lobbying for increased aid and transfers; (iv) eliminating illicit financial flows; (v) borrowing or restructuring debt, and (vi) adopting a more accommodative macroeconomic framework.’
‘[R]edirecting existing resources from one area to… social protection: (vii) re-allocating public expenditures, and; (viii) tapping into fiscal and foreign exchange reserves’ (Ortiz et al., 2017a: 1).

Sustainable financing at the country level also requires a good understanding of the political economy and why certain spending decisions are made. This includes consideration of how the projected costs of social protection relate to national government spending priorities and long-term financing commitments. Two recent studies by the United Nations University World Institute for Development Economics Research (UNU-WIDER) highlight that while fiscal capacity is required for social protection resource allocation in this area, institutions, ideology and politics also play an important role (Murshed et al., 2017; Seekings, 2017).

Individuals/households: The second largest source of social protection financing is out-of-pocket expenses paid by service users, but this mainly applies to health expenses (Barrientos, 2007). People may choose between a number of options for financing social protection: investment in human capital (self-protection), savings, and insurance (ibid.). Micro-savings may be an appropriate way to self-fund as they are effective in small losses–high frequency contingencies although, if microfinance institutions make savings compulsory and discourage easy access to withdrawals, they may provide only limited social protection (ibid.).

Employers: Employers’ and workers’ contributions play a critical role in financing social insurance schemes (ILO, 2018: 6). In higher-income countries, social insurance often covers most of the population, with non-contributory (universal or means-tested) interventions for the poor, while in poorer countries, ‘poverty-targeted social assistance programmes tend to play a relatively larger role, though benefits tend to be low, with social insurance providing more adequate benefits’ (ibid.). Contributory schemes tend to ‘guarantee protection in the case of specific risks or contingencies, such as unemployment, sickness, maternity, disability, employment injury or old age’ (UNDP, 2016: 34). Often these schemes include a non-contributory element to distribute benefits more equitably and cover people with low incomes, for example, through within-scheme redistribution or partial funding from general taxation sources through the government budget (ibid.). See Social insurance.

Development assistance: Donors continue to have an important role in providing finance for social protection in low-income countries. There is a consensus that this is within the context of moving towards domestic financing of social protection costs, including by funding and support of social protection systems rather than just supporting individual programmes. Moreover, there will be circumstances (e.g. after a shock) when countries may not be able to cover their social protection needs out of their own resources and international support will be required (IATF, 2017: 25). However, the ILO 2018 baseline on social protection in development aid reported that ‘the levels of ODA allocated to social protection reflect the relatively low priority given to this development area’: social protection assistance accounts for 0.84% of DAC countries’ total disbursed ODA (ILO, 2018: 4). In 2015, ‘the three most important recipients of social protection ODA (in terms of their participation in GDP) were Rwanda, the West Bank and Gaza Strip and Malawi (at between 0.64 per cent of GDP and 2.3 per cent of GDP)’ (ibid.: 4–5).

Taxation

There is increasing awareness that issues of taxation and social protection should be considered together (Bastagli, 2015). On the other hand, ‘tax revenue levels and “mix” matter… for levels of revenues available for social protection spending and for its sustainability over time’ (ibid.: vi). A true assessment of the distributional effects of social protection and the extent to which social protection reduces poverty can only be done by looking at the combined effect of taxes and transfers (Hirvonen et al., 2016).

Efforts to support domestic social protection spending are increasingly looking at options to grow taxation revenue (Bastagli, 2015: iv). The Inter-agency Task Force (IATF, 2017: 24) notes that ‘Building synergies between the social protection and tax systems can strengthen the social contract between citizen and state, as expansion of the tax base coincides with provision of benefits.’ Compared with other social protection financing options (e.g. expenditure reallocation and donor support), the advantages of taxation include ‘the potential for tax systems to promote government accountability and, in turn, improved service provision and citizens’ willingness to pay taxes’ (Bastagli, 2015: vi). At the same time, ‘there is scope to extend contributory social protection and tackle distinctive “revenue gaps” related to tax exemptions and incentives, the undertaxation of… high net-worth individuals, and tax avoidance and evasion’ (ibid.).

Studies that consider the effects of social protection on poverty and inequality also increasingly take account of the role that taxation plays. While transfers may be effective in redistributing income and thereby reducing poverty, such effects are undermined and possibly reversed if those at the lower end of the income distribution are disproportionately affected by taxes such as VAT or income tax (Higgins & Lustig, 2016; Hirvonen et al., 2016). Studies of the joint distributional effects of social protection and taxation in low- and middle-income countries are limited but increasing.

Key texts

Ortiz, I., Cummins, M., & Karunanethy, K. (2017a). Fiscal space for social protection and the SDGs: Options to expand social investments in 187 countries (ESS Working Paper 48). Geneva: International Labour Office
This paper offers eight options that should be explored to expand fiscal space and generate resources to achieve the SDGs, realise human rights, and invest in women and children. It provides examples of where these options have been applied by governments around the world.

Ortiz, I., Durán-Valverde, F., Pal, K., Behrendt, C., & Acuña-Ulate, A. (2017b). Universal social protection floors: Costing estimates and affordability in 57 lower income countries (ESS Working Paper 58). Geneva: ILO.
This paper presents the results of costing universal social protection floors in 34 lower middle-income, and 23 low-income countries, consisting of: (i) allowances for all children and all orphans; (ii) maternity benefits for all women with newborns; (iii) benefits for all persons with severe disabilities; and (iv) universal old-age pensions.

Bastagli, F. (2015). Bringing taxation into social protection analysis and planning (ODI Working Paper 421). London: ODI.
‘This paper contributes to efforts to include tax considerations in social protection analysis and design by discussing the key methodological issues in carrying out joint distributional analysis, reviewing the evidence on the incidence and distributional impact of taxes and transfers and discussing alternative tax revenue sources and their implications for social protection financing and sustainability’ (abstract).

Other resources

Conference/seminar/webinar: Financing gender-responsive social protection. (2019). ODI & DFID.

Podcast: Strong safety nets strong growth. (2019). International Monetary Fund. (16m:28)

[1] Calculations are ‘based on a comparable set of cash transfers, comprising of: (i) allowances for all children and orphans; (ii) maternity benefits for all women with newborns; (iii) benefits for all persons with severe disabilities, and (iv) universal old-age pensions’, and include 3% administrative costs for all universal benefits (Ortiz et al., 2017b: 2).