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R. Lee, A. Fürnkranz-Prskawetz, M. Sánchez-Romero:
"Redistributive Effects of Pension Schemes If Individuals Differ By Life Expectancy";
Talk: European Population Conference 2018, Brüssel; 2018-06-06 - 2018-06-09.

We set up a general equilibrium model in which heterogeneous individuals by level of learning ability and life expectancy optimally decide about their consumption/saving path, the length of schooling, and their labor supply, both at the intensive margin (hours worked) and at the extensive margin (retirement age). To account for the marginal effects that mortality and health may have on the length of schooling and retirement age, we follow Sánchez-Romero et al. (2016) and Bloom et al. (2014). Moreover, the model is implemented so as to simultaneously analyze the effects that any pension system (Funded/PAYG with Defined Contribution or Defined Benefit) might have on the optimal decisions, even though the model will be calibrated to the US case.

Motivation

Many countries have experienced an impressive increase in life expectancy accompanied by a rise in the number of healthy life years. The improvements in morbidity and mortality have been accompanied by decreases in fertility. These demographic developments will lead to an increase in the proportion of retirees per worker, thereby putting pressure on current pension systems. Reforms of the social security system, such as postponing the retirement age or reducing the generosity of the system, are inevitable. However, within countries, the difference in life expectancy between the high and low socioeconomic groups has also widened in recent decades. For instance, in the US, this difference may be as large as 10-14 years between those of high and low socioeconomic status. Given that pension systems have a strong age component, since contributions are paid during working years while benefits are received at retirement, ignoring this heterogeneity might jeopardize any reform as the "ex ante" actuarial fairness and the progressivity of the system becomes "ex ante" highly regressive.

The proposed reforms of the pension system need to take into account that individual ageing is heterogeneous across socioeconomic groups. Moreover, it is necessary to investigate how alternative pension reforms impact the decisions of heterogeneous individuals by socioeconomic status and whether the reforms are capable of restoring the "ex ante" actuarial fairness and progressivity of the system across socioeconomic groups. For such studies we need models of the pension system that account for the behavioral response of individuals that differ by their life expectancy. Sketch of the model

We set up a general equilibrium model in which heterogeneous individuals by level of learning ability and life expectancy optimally decide about their consumption/saving path, the length of schooling, and their labor supply, both at the intensive margin (hours worked) and at the extensive margin (retirement age). To account for the marginal effects that mortality and health may have on the length of schooling and retirement age, we follow Sánchez-Romero et al. (2016) and Bloom et al. (2014). Moreover, the model is implemented so as to simultaneously analyze the effects that any pension system (Funded/PAYG with Defined Contribution or Defined Benefit) might have on the optimal decisions, even though the model will be calibrated to the US case. Simulations and discussion

To evaluate the impact of the pension reforms on old-age inequality, we calculate the present, survival weighted value of lifetime pension benefits across different socioeconomic groups and birth cohorts. Moreover, we investigate the effect that alternative pension reforms have on the length of schooling, retirement, and labor supply. To understand the role of pension systems for labor force, we provide estimates of the implicit tax/subsidy generated by each pension system at the intensive margin and also at the extensive margin (a la Gruber and Wise).

First simulation results of the present value of lifetime pension benefits at age 50 by income quintile are presented in Figure 1 for four different PAYG pension systems: (i) Notional Defined Contribution (NDC) with an average cohort-life table (DC-AM), (ii) NDC with a cohort-life table for each income quintile (DC-DM), (iii) PAYG-Defined Benefit system with a constant replacement rate (DB-NP), and (iv) the US pension system (DB-P). Figure 1 shows that although the US pension system is the most progressive of the four pension systems for the 1930 birth cohort, the increasing longevity gap across income quintiles (c.f., cohorts 1930 and 1960) leads the US pension system to not redistribute across income quintiles as well as a notional defined contribution system that uses specific cohort-life tables by income quintiles. This result suggests that reforms of the US pension system should take into account the increasing longevity gap across socioeconomic groups.

Figure 1. Present Value of Lifetime Pension Benefits by Income Quintile and PAYG Pension System, Under Mortality Regimes of the 1930 and 1960 US Birth Cohorts for Males in 1000's of US$

Source: Lee and Sanchez-Romero (2017). Note: Risk-free market discount rate = 3%. Results for cohort 1960 are detrended of labor productivity growth. Pay-as-you-go pension systems: Defined Contribution system using the average cohort-specific life table (DC-AM), Defined Contribution system using the cohort-specific life table by income-quintile (DC-DM), Defined Benefit system with a constant replacement rate (DB-NP), and Defined Benefit system with an "ex ante" progressive replacement rate (DB-P).