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The shadow of longevity – does social security reform reduce gains from increasing the retirement age

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The shadow of longevity – does social security reform reduce gains from increasing the retirement age

  1. 1. Introduction Model Scenarios Calibration Results The shadow of longevity – does social security reform reduce gains from increasing the retirement age? with Karolina Goraus, Krzysztof Makarski and Joanna Tyrowicz Marcin Bielecki Faculty of Economics, University of Warsaw First World Congress of Comparative Economics Rome, 25-27 June 2015 1 / 30
  2. 2. Introduction Model Scenarios Calibration Results Motivation Major issues in pension economics: increasing old-age dependency ratio majority of pension systems fail to assure actuarial fairness in most countries people tend to retire as early as legally allowed 2 / 30
  3. 3. Introduction Model Scenarios Calibration Results Motivation Major issues in pension economics: increasing old-age dependency ratio majority of pension systems fail to assure actuarial fairness in most countries people tend to retire as early as legally allowed Typical reform proposals switch to DC systems and strengthen the link between contributions and benefits raise the social security contribution rate cut government expenditure increase minimum eligibility retirement age 2 / 30
  4. 4. Introduction Model Scenarios Calibration Results Effective retirement age in OECD 3 / 30
  5. 5. Introduction Model Scenarios Calibration Results Participation rates in OECD 4 / 30
  6. 6. Introduction Model Scenarios Calibration Results Outline 1 Introduction 2 Model 3 Scenarios 4 Calibration 5 Results 5 / 30
  7. 7. Introduction Model Scenarios Calibration Results Literature review Two streams of literature: 1 Answering the question about optimal retirement age Gruber and Wise (2007), Galasso (2008), Heijdra and Romp (2009) 2 Comparing different pensions system reforms: increasing retirement age vs cut in benefits/privatization of the system/... Auerbach et al. (1989), Hviding and Marette (1998), Fehr (2000), Boersch-Supan and Ludwig (2010), Vogel et al. (2012) Fehr (2000) Macroeconomic effects of retirement age increase may depend on the existing relation between contributions and benefits Remaining gaps in the literature how the macroeconomic effects differ between various pension systems? what happens to the welfare of each affected generation and why? 6 / 30
  8. 8. Introduction Model Scenarios Calibration Results Goals and expectations Goal Analyse macroeconomic and welfare implications of retirement age increase under DB (defined benefit), NDC (notionally defined contribution) and FDC (funded defined contribution) systems Expectations under DB: leisure ↓, taxes ↓, welfare? under DC: leisure ↓, pensions ↑, welfare? difference between FDC & NDC: pricing of capital? Why a full model? Labor supply adjustments & GE effects 7 / 30
  9. 9. Introduction Model Scenarios Calibration Results Model structure: consumers I ”born” at age 20 (j = 1) and live up to 100 years (J = 80) subject to time and cohort dependent survival probability π choose labor supply l endogenously until exogenous retirement age ¯J (forced to retire) 8 / 30
  10. 10. Introduction Model Scenarios Calibration Results Model structure: consumers I ”born” at age 20 (j = 1) and live up to 100 years (J = 80) subject to time and cohort dependent survival probability π choose labor supply l endogenously until exogenous retirement age ¯J (forced to retire) optimize remaining lifetime utility derived from leisure 1 − l and consumption c Uj,t = J−j s=0 δs πj+s,t+s πj,t u(cj+s,t+s, lj+s,t+s) with u(c, l) = log(cφ (1 − l)1−φ ) 8 / 30
  11. 11. Introduction Model Scenarios Calibration Results Model structure: consumers II receive market clearing wage for labor receive market clearing interest rate on private savings receive pension income receive unintentional bequests pay taxes 9 / 30
  12. 12. Introduction Model Scenarios Calibration Results Model structure: consumers II receive market clearing wage for labor receive market clearing interest rate on private savings receive pension income receive unintentional bequests pay taxes Subject to the budget constraint (1 + τc t )cj,t + sj,t = (1 − τl t )(1 − τι )wj,tlj,t ← labor income + (1 + (1 − τk t )rt)sj−1,t−1 ← capital income + (1 − τl t )pι j,t ← pension income + bj,t ← bequests − Υt ← lump-sum tax 9 / 30
  13. 13. Introduction Model Scenarios Calibration Results Model structure: producers perfectly competitive representative firm standard Cobb-Douglas production function Yt = Kα t (ztLt)1−α profit maximization implies wt = zt(1 − α)kα t rt = αkα−1 t − d with k ≡ K zL 10 / 30
  14. 14. Introduction Model Scenarios Calibration Results Model structure: government collects taxes on earnings, interest and consumption (sum up to T) spends GDP fixed share of GDP on government consumption G collects social security contributions and pays out pensions of DB and NDC system subsidyt = τι ¯J−1 j=1 wj,tlj,t − J j= ¯J pj,tNj,t services debt D and maintains debt/GDP ratio fixed lump-sum taxes Υ adjust to satisfy the govt budget constraint Gt + subsidyt + (1 + rt)Dt−1 = Tt + Dt + Υt J j=1 Nj,t 11 / 30
  15. 15. Introduction Model Scenarios Calibration Results Pension systems Defined Benefit: constructed by imposing a mandatory exogenous contribution rate τ and an exogenous replacement rate ρ pDB ¯J,t = ρw ¯J−1,t−1l ¯J−1,t−1 indexed by 25% of total payroll growth Defined Contribution: constructed by imposing a mandatory exogenous contribution rate τ and actuarially fair individual accounts pDC ¯J,t = accumulated sum of contributions ¯J,t expected remaining lifetime ¯J,t Notional: contributions before retirement and pensions are indexed by 25% of total payroll growth Funded: contributions before retirement and pensions are indexed by market interest rate 12 / 30
  16. 16. Introduction Model Scenarios Calibration Results What we do What happens within each experiment? 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 effect positive ⇒ reform efficient Welfare analysis – like Nishiyama & Smetters (2007) Macroeconomic analysis 13 / 30
  17. 17. Introduction Model Scenarios Calibration Results Reforms Three experiments: 1 DB with flat retirement age → DB with increasing retirement age 2 NDC with flat retirement age → NDC with increasing retirement age 3 FDC with flat retirement age → FDC with increasing retirement age Increasing retirement age 14 / 30
  18. 18. Introduction Model Scenarios Calibration Results Robustness: age-productivity profile Heterogeneity between cohorts due to age-specific productivity: wj,t = ωjwt Deaton (1997) decomposition on Polish LFS data 15 / 30
  19. 19. Introduction Model Scenarios Calibration Results Calibration to replicate 1999 economy of Poland Preference for leisure (φ) chosen to match participation rate of 56.8% Impatience (δ) chosen to match interest rate of 7.4% Replacement rate (ρ) chosen to match benefits/GDP ratio of 5% Contributions rate (τ) chosen to match SIF deficit/GDP ratio of 0.8% Labor income tax (τl ) set to match PIT/GDP ratio Consumption tax (τc ) set to match VAT/GDP ratio Capital income tax (τk ) set de iure = de facto 16 / 30
  20. 20. Introduction Model Scenarios Calibration Results Calibrated parameters Age-productivity profile ω – D97 ω = 1 α capital share 0.31 0.31 τl labor income tax 0.11 0.11 τc consumption tax 0.11 0.11 τk capital income tax 0.19 0.19 φ leisure-consumption preference 0.578 0.526 δ discounting rate 0.998 0.979 d depreciation rate 0.045 0.045 τ social security contribution 0.060 0.060 ρ replacement rate 0.138 0.227 resulting (dk)/y investment rate 21 21 r interest rate 7.4 7.4 17 / 30
  21. 21. Introduction Model Scenarios Calibration Results Exogenous processes in the model I Demographic projection until 2060, after that 80 years, and after that “new steady state” “Births” of 20-year olds from the projection, constant afterwards Mortality rates from the projection, constant afterwards 18 / 30
  22. 22. Introduction Model Scenarios Calibration Results Exogenous processes in the model II Productivity growth Labor augmenting productivity parameter z Projection from AWG, after that “new steady state”, 1.7% 19 / 30
  23. 23. Introduction Model Scenarios Calibration Results Is the reform efficient? Yes! Net consumption equivalent ω – D97 ω = 1 DB 9.88% 3.70% Transition to NDC 11.31% 4.41% Transition to FDC 11.81% 4.70% 20 / 30
  24. 24. Introduction Model Scenarios Calibration Results Everybody gains 21 / 30
  25. 25. Introduction Model Scenarios Calibration Results Why they gain? Benefits under DC systems ... 22 / 30
  26. 26. Introduction Model Scenarios Calibration Results ... and taxes under DB system SIF deficit Lump-sum taxes 23 / 30
  27. 27. Introduction Model Scenarios Calibration Results Is there any behavioral response? Of course! 24 / 30
  28. 28. Introduction Model Scenarios Calibration Results Labor supply in the final steady state Labor supply Labor supply with MERA increase (no reform) j < 60 j ≥ 60 Total Average Average Aggregate Average Aggregate (base=100%) (base=100%) DB 63.2% 59.6% 94.4% 71.8% 113.7% NDC 62.0% 58.8% 94.8% 72.3% 114.7% FDC 61.7% 59.0% 95.5% 72.2% 115.4% 25 / 30
  29. 29. Introduction Model Scenarios Calibration Results Aggregate labor supply (in millions of individuals) 26 / 30
  30. 30. Introduction Model Scenarios Calibration Results Capital per effective unit of labor decreases ... 27 / 30
  31. 31. Introduction Model Scenarios Calibration Results ... but mostly due to decrease in “precautionary savings” 28 / 30
  32. 32. Introduction Model Scenarios Calibration Results Conclusions extending the retirement age is universally welfare enhancing some downward adjustment in individual labor supply, but the aggregate labor supply increases effects on capital are “overstated” 29 / 30
  33. 33. Introduction Model Scenarios Calibration Results Thank you for your attention! Questions or suggestions? 30 / 30

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