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Executive Summary #1381es on Social Security

June 29, 2000

Executive Summary: Pension Reform in Sweden: Lessons for American Policymakers

By and

Sweden was the first nation in the world to implement a universal government-run retirement system, but today it is in the process of privatizing part of its pension program. Facing problems similar to those that beset the U.S. Social Security system, the Swedes decided that personal accounts were the best way of ensuring that today's workers would enjoy a safe and comfortable retirement.

Sweden's former pension system was a tax-financed, pay-as-you-go entitlement program, similar to the United States' Social Security program. And like in the systems in the United States and other industrialized nations, demographic and financial changes were straining Sweden's tax-and-transfer pension programs. There were only two solutions: Raise taxes and cut benefits to prolong solvency, or give workers private retirement accounts.

In Sweden, policymakers decided that privatization was the best solution. The new system has four key features:

  • Partial privatization. Workers can invest 2.5 percentage points of the 18.5 percent of their income that they must set aside for retirement. Soon workers will be able to choose the pension fund into which their funds will go.

  • Notional accounts. The remaining payroll tax funds a dramatically restructured pay-as-you-go government program. Instead of paying benefits based on years in the workforce and earnings history, the new system provides a pension based on the amount of taxes a worker has paid into the system.

  • Safety net to protect the poor. The government will continue to guarantee a minimum pension funded by general tax revenues.

  • Transition to protect retirees and older workers. Current retirees and older workers will continue to receive retirement income based on the old program. Workers born from 1938 to 1953 will receive benefits from both the old and new systems as the new system is gradually introduced.

Swedish workers and retirees will benefit from these reforms. The combination of partial privatization and reform of the pay-as-you-go portion of the retirement system will result in a fiscally sustainable system. In addition, private investments over time will allow workers to benefit from compounding returns, which will increase retirement income. Finally, the reform will benefit the Swedish economy. By reducing the payroll tax rate and linking income to pension benefits, Swedish pension reform will increase incentives to work. The shift to a funded system will also increase national savings and provide capital for future growth.

The changes in Sweden's pension system provide important lessons for any country facing the problems inherent in pay-as-you-go, tax-and-transfer pension programs, including the United States. The first lesson is that reform works. As the Swedish reforms demonstrate, countries can change from a pay-as-you-go entitlement program to personal accounts. The second lesson is that reform is popular. Although many consider Sweden the ultimate welfare state, legislators from the right and left united in support of the new privatized system. They saw that the pension program could not continue to function as it had been. As a result, these lawmakers created a stronger retirement system for the Swedish people.

There are many benefits to Sweden's new system, including greater incentives to work, increased national savings, a flexible retirement age, lower taxes and less government spending, opportunities for more reform, a fairer system that no longer redistributes income from the poor to the rich, and greater retirement income for retirees. The reforms in Sweden could be a model for U.S. lawmakers as they grapple with the problem of Social Security.

In Sweden, pension reform has created a better system--better for retirees, better for workers, and better for the economy as a whole. The same advantages would accrue to Americans and the American economy--but only if U.S. lawmakers learn the right lessons from what is happening in other nations.

Göran Normann, Ph.D., President of Normann Economics International, based in Stockholm and Paris, is an associate professor of economics at the University of Lund, Sweden. He has worked with the Federation of Swedish Industries and the Organisation for Economic Co-operation and Development (OECD). Daniel J. Mitchell, Ph.D., is McKenna Senior Fellow in Political Economy at The Heritage Foundation.

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