Modeling Polish Pension Reforms

1. Modeling the pension reforms 1 Macroeconomic modeling of the pension reforms Work in progress The views expressed herein are those of the authors and not necessarily those of Narodowy Bank Polski Krzysztof Makarski 12 Joanna Tyrowicz234 Jan Hagemejer23 with the assistance of Agnieszka Borowska and Karolina Goraus 1 Warsaw 2 Faculty School of Economics of Economics, University of Warsaw 3 Economic 4 Rimini Institute, National Bank of Poland Center for Economic Analyses Narodowy Bank Polski, December, 2013 1 / 55

2. Modeling the pension reforms Motivation The big(ger) picture A (too) broad scientic project at the University of Warsaw OLG modeling of the pension system reform in Poland (Our intended) Contributions: 1 2 scal closures have welfare eects (Pareto ecient reform?) labor market eects when intensive and extensive margin is combined with indivisibility of labor 3 political stability of pension reforms We have (almost) completed (1), still work on (2) and (3) Today: the-best-of two papers written in stage (1) 1 2 Welfare eects of various scal closures for 1999 reform Unprivatizing the pension system: welfare and macroeconomic eects of 2011 and 2013 reforms 2 / 55

6. Modeling the pension reforms Motivation Questions How dierent scal closures of the pension system reform aect welfare? welfare eect of the reform (aggregate and across generations)? extent of scal adjustment for dierent scal closures pensions macroeconomic variables What are the eects of changes proposed/implemented recently? additional welfare redistribution across cohorts changes to pensions and replacement rates scal eect (debt/taxes) and capital 3 / 55

7. Modeling the pension reforms Motivation Questions How dierent scal closures of the pension system reform aect welfare? welfare eect of the reform (aggregate and across generations)? extent of scal adjustment for dierent scal closures pensions macroeconomic variables What are the eects of changes proposed/implemented recently? additional welfare redistribution across cohorts changes to pensions and replacement rates scal eect (debt/taxes) and capital 3 / 55

8. Modeling the pension reforms Model Roadmap 1 Motivation 2 Model 3 Calibration 4 Welfare eects of scal closures 5 Unprivatizing the pension system 6 Summary 4 / 55

9. Modeling the pension reforms Model Model overview OLG model with endogenous labor and savings Heterogeneity across cohorts (mortality and labor productivity) No heterogeneity within cohorts Agents have time inconsistent preferences Exogenous retirement age and demographics Competitive producers with CD production function Pension system + pension system reform Inter-generational transfers + utility to compare welfare across time with changing demographics Dierent scal closures (to do scal rules) Calibrated to the Polish economy 5 / 55

10. Modeling the pension reforms Model What we do not know before modeling? 1999 reform: DB PAYG ⇒ NDC + FDC = partially funded DC part of contributions stay in the PAYG system (SIF) part of contributions shifted away (OPFs) + scal tension today lower replacement rates + ease scal tension in future comparing the steady states is not enough - transitory welfare eects BUT SIF gap needs to be nanced ⇒ possible scal closures with own welfare eects ve closures: lump sum, labor tax, consumption tax, debt + labor tax, debt + consumption tax we cannot tell ex ante which scal closure is better? eect for savings, labor supply and output? 6 / 55

14. Modeling the pension reforms Model Consumers ¯ Are free to choose how much to work, but only until J (forced to retire) Optimize lifetime utility derived from leisure and consumption J−j δs Uj (cj,t , lj,t ) = uj (cj,t , lj,t ) + β s=1 πj+s,t+s u (cj+s,t+s , lj+s,t+s ) πj,t (1) subject to ι (1 + τc,t )cj,t + sj,t + τj + Υt = (1 − τj,t − τl,t )wj,t lj,t ← labor income + (1 + rt (1 − τk,t ))sj,t−1 ← capital income + (1 − τl,t )pι,j,t + bj,t ← pensions + bequests where u(c, l) = φ log(c) + (1 − φ) log(1 − l) 7 / 55

15. Modeling the pension reforms Model Producers maximize k Yt − wt Lt − (rt + d)Kt subject to α Yt = Kt (zt Lt )1−α where the path of {z}∞ is exogenous (calibrated to AWG, by EC) t=0 Interest rate k interest rate on capital rt = M P K − d, endogenous G k (riskless) interest rate on government debt to be rt = 0.33 · rt households (and pension funds) by public debt inelastically returns on savings yield a linear combination of risky and risk-less 8 / 55

16. Modeling the pension reforms Model Producers maximize k Yt − wt Lt − (rt + d)Kt subject to α Yt = Kt (zt Lt )1−α where the path of {z}∞ is exogenous (calibrated to AWG, by EC) t=0 Interest rate k interest rate on capital rt = M P K − d, endogenous G k (riskless) interest rate on government debt to be rt = 0.33 · rt households (and pension funds) by public debt inelastically returns on savings yield a linear combination of risky and risk-less 8 / 55

17. Modeling the pension reforms Model Public nances SIF collects social security contributions and pays out pensions J subsidyt = τtι · wt Lt − bj,t πj,t Nt−j (2) ¯ j=J any debt/surplus in SIF is government debt/surplus Government collects taxes on earnings, interest and consumption + Υ spends xed amount of GDP/money + services debt long run debt/GDP ratio xed to nance pension system can use taxes or debt ⇐ scal closures 9 / 55

18. Modeling the pension reforms Model Public nances SIF collects social security contributions and pays out pensions J subsidyt = τtι · wt Lt − bj,t πj,t Nt−j (2) ¯ j=J any debt/surplus in SIF is government debt/surplus Government collects taxes on earnings, interest and consumption + Υ spends xed amount of GDP/money + services debt long run debt/GDP ratio xed to nance pension system can use taxes or debt ⇐ scal closures 9 / 55

19. Modeling the pension reforms Model Pension systems initial steady state: PAYG Dened Benet (DB), τtι = τ DB after the original reform: NDC + FDC (two pillars) τ = τ I + τ II NDC = contributions indexed with growth of payroll + benet actuarially fair + post retirement indexation with 20% of payroll growth FDC = contributions earn interest + benet actuarially fair + post retirement also earn interest JVR reform = ve components: (one o ) shift of bonds (permanent) voluntary participation in FDC (permanent) FDC savings portfolio (mostly) has assets (permanent) reducing contribution rate to FDC slider/zipper 10 / 55

22. Modeling the pension reforms Model Solution method: Gauss-Seidel algorithm Start from the initial steady state Assume the economy eventually achieves the new steady state Reform is unexpected Algorithm Guess k per worker (or path) and compute wt , rt t = 0T Compute individual choices (may need value functions). Aggregate to get new If |k − k | err k (or path) nish Just in case ... check feasibility No contraction mapping theorem 11 / 55

26. Modeling the pension reforms Model How do we know what is better? LSRA! Lump Sum Redistribution Authority as Nishiyama Smetters (2007) 1 Run the no policy change scenario ⇒ baseline 2 Run the policy change scenario ⇒ reform 3 For each cohort compare utility, compensate the losers from the winners 4 If net eect positive ⇒ reform ecient 5 Run reform again, with the compensation, to observe GE eects What is baseline? Always the same: births, mortality, productivity and retirement age 1999 Reform: baseline = PAYG DB | reform = NCD + FDC JVR: baseline = NDC+FDC | reform = changes to features 12 / 55

30. Modeling the pension reforms Calibration Roadmap 1 Motivation 2 Model 3 Calibration 4 Welfare eects of scal closures 5 Unprivatizing the pension system 6 Summary 13 / 55

31. Modeling the pension reforms Calibration Baseline: no of births (20 year olds): Demographic projection (2060), constant afterwards (conservative) 14 / 55

32. Modeling the pension reforms Calibration Baseline: mortality rates Demographic projection (2060), constant afterwards 15 / 55

33. Modeling the pension reforms Calibration Baseline: old age dependency ratio Demographic projection (2060), constant afterwards 16 / 55

34. Modeling the pension reforms Calibration Baseline: labor augmenting technological progress Historical data, projection from AWG, new steady state at 1.7% 17 / 55

35. Modeling the pension reforms Calibration Baseline: retirement age Historical data, assumed (based on law) afterwards 18 / 55

36. Modeling the pension reforms Calibration Baseline (outcomes): pension benets in GDP Aging plus decreasing labor force 19 / 55

37. Modeling the pension reforms Calibration Calibration to replicate 1999 economy Preference for leisure (φ) matches participation rate of 56.8% Replacement rate (ρ) matches benets/GDP ratio of 5% Contributions rate (τ ) matches SIF decit/GDP ratio of 0.8% Labor income tax (τl ) set to 11% to match PIT/GDP ratio Consumption tax (τc ) set to match VAT/GDP ratio Capital tax (τk ) de iure = de facto The initial capital 20 / 55

38. Modeling the pension reforms Calibration Life cycle productivity: at or Deaton (1997) 21 / 55

39. Modeling the pension reforms Calibration Parameters for dierent calibrations Calibrated parameters β=1 ω=1 ω φ δ d tl τ ρ D97 0.538 0.576 β = 0.9 ω = 1 ω - D97 β = 0.8 ω=1 ω - 0.535 0.5772 0.537 0.579 D97 0.981 0.998 0.99 1.0033 0.994 1.009 0.0415 0.055 0.053 0.055 0.055 0.06 0.11 0.11 0.11 0.11 0.11 0.11 0.063 0.0603 0.0608 0.0608 0.0606 0.0611 0.27 0.15 0.253 0.153 0.255 0.155 resulting xt /yt r 21.1 21.2 21.2 21.2 21.1 21.1 7.5 7.5 7.5 7.5 7.5 7.5 Note: D97: Deaton (1997) decomposition. 22 / 55

40. Modeling the pension reforms Welfare eects of scal closures Roadmap 1 Motivation 2 Model 3 Calibration 4 Welfare eects of scal closures 5 Unprivatizing the pension system 6 Summary 23 / 55

41. Modeling the pension reforms Welfare eects of scal closures Results SIF decit resulting from the reform is nanced ... ... by labor tax or consumption tax ⇒ debt share in GDP is held constant, so are taxes, but τl or τc is adjusted among all the living ... by debt which is later repaid with labor or consumption tax ⇒ debt share in GDP grows to a threshold of 70%, with all taxes held constant, then debt gets automatically reduced to 45% of GDP exponentially, τc or τl is adjusted for living then onwards ... by lump sum taxes on all living generations ⇒ debt share in GDP and tax rates are held constant, Υ is adjusted among all the living 24 / 55

44. Modeling the pension reforms Welfare eects of scal closures Results: Welfare LSRA after redistribution (% of perm. cons.) Fiscal closure β=1 β = 0.9 β = 0.8 at D97 at D97 at D97 τl 1.2% 0.6% 0.8% 0.4% 0.5% 0.2% Debt/τl 1.3% 0.6% 0.8% 0.4% 0.5% 0.2% τC 1.2% 0.7% 0.8% 0.4% 0.5% 0.3% Debt/τC 1.2% 0.6% 0.8% 0.4% 0.5% 0.2% Υt 1.2% 0.7% 0.8% 0.4% 0.4% 0.2% Note: D97 denotes calibration according to Deaton (1997) decomposition. 25 / 55

45. Modeling the pension reforms Welfare eects of scal closures Results: Fiscal adjustment Extent of scal adjustment - debt/consumption tax Reform: Higher taxes initially, become lower after a while. 26 / 55

46. Modeling the pension reforms Welfare eects of scal closures Results: Fiscal adjustment Extent of scal adjustment - debt/labor tax Reform: Higher taxes initially, become lower after a while. 27 / 55

47. Modeling the pension reforms Welfare eects of scal closures Results: Fiscal adjustment Extent of scal adjustment - labor tax Higher taxes initially, become lower after a while. 28 / 55

48. Modeling the pension reforms Welfare eects of scal closures Results: Fiscal adjustment Extent of scal adjustment - consumption tax Higher taxes initially, become lower after a while. 29 / 55

49. Modeling the pension reforms Welfare eects of scal closures Results: Fiscal adjustment Extent of scal adjustment - lump sum tax Higher taxes initially, become lower after a while. Note; lump sum taxes have real eects (redistribution) 30 / 55

50. Modeling the pension reforms Welfare eects of scal closures Results: Pensions Replacement rates - relative to baseline Pensions are substantially reduced by PAYG DB → DC Fiscal closure matters little Initial cohorts unaected 31 / 55

51. Modeling the pension reforms Welfare eects of scal closures Results: Macroeconomic eects Closure GDP Period D97 ω at Labor supply ω D97 ω at ω Capital D97 ω at ω 10 0.6% 0.7% -0.9% -0.5% 1.8% 2.3% 50 2.2% 2.0% -1.3% 0.9% 7.2% 6.4% ∞ 2.5% 2.1% -1.2% 0.4% 8.3% 7.0% 10 0.6% 0.7% -0.8% -0.2% 1.9% 2.4% Consumption 50 2.9% 2.7% -0.6% 1.1% 9.8% 9.1% tax ∞ 2.4% 2.0% -0.9% 0.5% 7.8% 6.7% 10 0.2% 0.2% -0.3% 0.1% 0.6% 0.5% Debt with 50 2.0% 1.8% -1.1% 1.1% 6.7% 5.8% τl ∞ 2.5% 2.1% -1.2% 0.4% 8.3% 7.0% 10 0.2% 0.1% -0.4% 0.1% 0.6% 0.4% Debt with 50 3.0% 2.8% -0.5% 1.1% 10.0% 9.2% τl ∞ 2.3% 2.0% -0.9% 0.5% 7.8% 6.7% 10 0.5% 0.6% -0.2% 0.4% 1.7% 2.1% Lump sum 50 2.2% 2.0% -1.9% -0.5% 7.3% 6.7% tax ∞ 2.6% 2.0% -2.3% -0.5% 8.5% 6.6% Labor tax 32 / 55

52. Modeling the pension reforms Welfare eects of scal closures Results: Distribution of welfare eects Welfare: all closures, no time inconsistency 33 / 55

53. Modeling the pension reforms Welfare eects of scal closures Results: Decomposition of welfare eects Decomposition - consumption tax (left) and debt/consumption tax (right) 34 / 55

54. Modeling the pension reforms Welfare eects of scal closures Results: Decomposition of welfare eects Decomposition - labor tax (left) and debt/labor tax (right) 35 / 55

55. Modeling the pension reforms Welfare eects of scal closures Results: Time inconsistency Time inconsistency - matters little for capital Capital - consumption tax closure and debt closure with consumption tax 36 / 55

56. Modeling the pension reforms Welfare eects of scal closures Results: Time inconsistency Time inconsistency - preserves the general ndings Welfare - consumption tax closure and debt with consumption tax closure 37 / 55

57. Modeling the pension reforms Welfare eects of scal closures 1999 reform - summary Generally, 1999 reform is welfare enhancing Our model calibrated to 1999 Polish economy Shows that welfare overall eects positive, but scal closure matters for (cohort) composition eects Considerable redistribution across cohorts needed Introduction of FDC makes debt desirable (redistributes) Pensions fall To do Log utility: taxes aect labor marginally (GHH preferences) Endogenous retirement 38 / 55

58. Modeling the pension reforms Welfare eects of scal closures 1999 reform - summary Generally, 1999 reform is welfare enhancing Our model calibrated to 1999 Polish economy Shows that welfare overall eects positive, but scal closure matters for (cohort) composition eects Considerable redistribution across cohorts needed Introduction of FDC makes debt desirable (redistributes) Pensions fall To do Log utility: taxes aect labor marginally (GHH preferences) Endogenous retirement 38 / 55

59. Modeling the pension reforms Unprivatizing the pension system Roadmap 1 Motivation 2 Model 3 Calibration 4 Welfare eects of scal closures 5 Unprivatizing the pension system 6 Summary 39 / 55

60. Modeling the pension reforms Unprivatizing the pension system Introduced changes JVR = changes to the pension system 2011 reform plus three policy options in 2013 reforms aect private savings and public debt (shift of bonds, przesuniecie obligacji) amount of savings in FDC voluntary participation (voluntariness, doborowolnosc) split between τ1 and τ2 (shift of contributions, przesuniecie skladki) portfolio structure of FDC (portfolio, portfel) the way pensions are paid out (slider, suwak) these changes too aect dierent cohorts dierently overall welfare eects undetermined Objectives with two scal closures: VAT cut or debt reduction ... ... evaluation of these amendments vs. status quo of unchanged pension system 40 / 55

68. Modeling the pension reforms Unprivatizing the pension system Macroeconomic eects Public debt in debt/tax closure (relative to baseline) Fiscal situation improves (which translates into lower debt) 41 / 55

69. Modeling the pension reforms Unprivatizing the pension system Macroeconomic eects Capital: debt reduction (left) and tax cut (right) Fiscal situation improves: debt or taxes may fall Long run: capital falls by up to 2% Short run: increases or declines depending on behavior of debt. 42 / 55

70. Modeling the pension reforms Unprivatizing the pension system Macroeconomic eects Return rates from pillars Growth rate of GDP vs. interest rate (implied by the model) 43 / 55

71. Modeling the pension reforms Unprivatizing the pension system Macroeconomic eects Replacement rates in relation to status quo 44 / 55

72. Modeling the pension reforms Unprivatizing the pension system Macroeconomic eects Pensions in relation to status quo 45 / 55

73. Modeling the pension reforms Unprivatizing the pension system Welfare consequences Zipper/slider (with tax closure) 46 / 55

74. Modeling the pension reforms Unprivatizing the pension system Welfare consequences Shift of contributions (with tax closure) 47 / 55

75. Modeling the pension reforms Unprivatizing the pension system Welfare consequences Voluntary participation (50%) (with tax closure) 48 / 55

76. Modeling the pension reforms Unprivatizing the pension system Welfare consequences Change in portfolio structure (only assets) (with tax closure) 49 / 55

77. Modeling the pension reforms Unprivatizing the pension system Welfare consequences All eects combined (with tax closure) 50 / 55

78. Modeling the pension reforms Unprivatizing the pension system Welfare consequences All eects combined (both closures) 51 / 55

79. Modeling the pension reforms Unprivatizing the pension system Welfare consequences Welfare (LSRA) Welfare decline mainly due to Lower pensions (due to lower replacement rates and unfavorable post-retirement indexation) Our model is veeeery merciful no change in government expenditure (actual welfare gains materialize) no within-cohort heterogeneity (no minimum pension benet) nal steady state population stationary 52 / 55

80. Modeling the pension reforms Unprivatizing the pension system Welfare consequences Welfare (LSRA) Welfare decline mainly due to Lower pensions (due to lower replacement rates and unfavorable post-retirement indexation) Our model is veeeery merciful no change in government expenditure (actual welfare gains materialize) no within-cohort heterogeneity (no minimum pension benet) nal steady state population stationary 52 / 55

81. Modeling the pension reforms Summary Roadmap 1 Motivation 2 Model 3 Calibration 4 Welfare eects of scal closures 5 Unprivatizing the pension system 6 Summary 53 / 55

82. Modeling the pension reforms Summary Proposed reform scenarios - summary Pensions decline (except in the 'portfolio' scenario) Public and debt will be: lower due to the zipper/slider, the shift of contributions and the voluntary participation in OPFs the shift of bonds - a one-o eect The change in GDP depends on the scal closure (crowding out) decrease in debt boosts capital accumulation and in turn GDP (transitory) in the long-run lower level of capital than in status-quo 54 / 55

85. Modeling the pension reforms Summary Welfare eects of unprivatizing? The 2013 reform is a combination of ve components: Voluntary participation in OPFs (assumption of 50% participation) One-o shift of bonds from OPFs back to government Shift of contributions A change in the portfolio structure The slider Overall welfare eect - negative (each component has negative eects) SIF decit goes down - debt or taxes may fall Welfare reduction mainly via lower pensions (some GE eects) Capital stock declines in the long run, in the short run adjustment depends on scal closure 55 / 55

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Modeling Polish Pension Reforms