Joanna Tyrowicz, Olivia Komada and Krzysztof Makarski
Group for Research in APplied Economics (GRAPE)
15th International Pension Workshop
Paris, May 2017
Chapter 2.ppt of macroeconomics by mankiw 9th edition
Welfare effects of fiscal policy in reforming the pension system
1. Motivation Model Calibration Calibration Results
Welfare effects of fiscal policy
in reforming the pension system
Joanna Tyrowicz
(with Olivia Komada and Krzysztof Makarski)
Group for Research in APplied Economics (GRAPE)
15th
International Pension Workshop
Paris, May 2017
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2. Motivation Model Calibration Calibration Results
Motivation
pension system reform ⇒ between and within cohort redistribution
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3. Motivation Model Calibration Calibration Results
Motivation
pension system reform ⇒ between and within cohort redistribution
fiscal policy may counteract or reinforce this adjustment
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4. Motivation Model Calibration Calibration Results
Literature differs in terms of used fiscal adjustment
lump-sum tax
Heer and Irmen (2008)
contribution rates
Kumru & Thanopoulos (2011), Bruce & Turnovsky (2013), Kitao (2014)
labor tax
Keuschnigg et al. (2012), Verbic et al. (2006)
debt
Belan and Pestieau (1999), Lindbeck & Persson (2003), Kumru & Piggott (2010), Wright et al.
(2012), Song et al. (2015)
consumption tax
Fehr (2000), Keuschnigg et al. (2012), Verbic et al. (2006), Diaz-Gimenez & Diaz-Saavedra
(2009), Fehr and Kindermann (2010), Kumru and Piggott (2010), De la Croix et al. (2012), Kitao
(2015),
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5. Motivation Model Calibration Calibration Results
Literature differs in terms of used fiscal adjustment
lump-sum tax
Heer and Irmen (2008)
contribution rates
Kumru & Thanopoulos (2011), Bruce & Turnovsky (2013), Kitao (2014)
labor tax
Keuschnigg et al. (2012), Verbic et al. (2006)
debt
Belan and Pestieau (1999), Lindbeck & Persson (2003), Kumru & Piggott (2010), Wright et al.
(2012), Song et al. (2015)
consumption tax
Fehr (2000), Keuschnigg et al. (2012), Verbic et al. (2006), Diaz-Gimenez & Diaz-Saavedra
(2009), Fehr and Kindermann (2010), Kumru and Piggott (2010), De la Croix et al. (2012), Kitao
(2015), Nishiyama & Smetters (2007)
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6. Motivation Model Calibration Calibration Results
Contribution
provide a systematic overview of the interaction between the pension
system reform and fiscal policy
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7. Motivation Model Calibration Calibration Results
Contribution
provide a systematic overview of the interaction between the pension
system reform and fiscal policy
propose new ways of financing the pensions system reform
public spending
tax progression
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8. Motivation Model Calibration Calibration Results
Contribution
provide a systematic overview of the interaction between the pension
system reform and fiscal policy
propose new ways of financing the pensions system reform
public spending
tax progression
is Nishiyama & Smetters (2007) result universal?
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9. Motivation Model Calibration Calibration Results
Our approach
OLG model with idiosyncratic productivity shocks
Procedure
Baseline: PAYG DB with aging and thus deficit
Reform: PAYG DB ⇒ partially funded DC
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10. Motivation Model Calibration Calibration Results
Our approach
OLG model with idiosyncratic productivity shocks
Procedure
Baseline: PAYG DB with aging and thus deficit
Reform: PAYG DB ⇒ partially funded DC
8 fiscal policies
2 pension system adjustments: contribution or benefits
6 fiscal closures: tax on labor (with/without debt adjustment),
consumption (with/without debt adjustment), progressive income tax,
public spending
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11. Motivation Model Calibration Calibration Results
Our approach
OLG model with idiosyncratic productivity shocks
Procedure
Baseline: PAYG DB with aging and thus deficit
Reform: PAYG DB ⇒ partially funded DC
8 fiscal policies
2 pension system adjustments: contribution or benefits
6 fiscal closures: tax on labor (with/without debt adjustment),
consumption (with/without debt adjustment), progressive income tax,
public spending
government maz behave differently in baseline and reform
→ 64 combinations
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12. Motivation Model Calibration Calibration Results
Our approach
OLG model with idiosyncratic productivity shocks
Procedure
Baseline: PAYG DB with aging and thus deficit
Reform: PAYG DB ⇒ partially funded DC
8 fiscal policies
2 pension system adjustments: contribution or benefits
6 fiscal closures: tax on labor (with/without debt adjustment),
consumption (with/without debt adjustment), progressive income tax,
public spending
government maz behave differently in baseline and reform
→ 64 combinations
compare welfare effect and political support
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15. Motivation Model Calibration Calibration Results
Results preview
fiscal closure does matter
in short ...
... and long run
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16. Motivation Model Calibration Calibration Results
Results preview
fiscal closure does matter
in short ...
... and long run
welfare may by improved (in Hicks sense) ...
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17. Motivation Model Calibration Calibration Results
Results preview
fiscal closure does matter
in short ...
... and long run
welfare may by improved (in Hicks sense) ...
... and with sufficient political support
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18. Motivation Model Calibration Calibration Results
Results preview
fiscal closure does matter
in short ...
... and long run
welfare may by improved (in Hicks sense) ...
... and with sufficient political support
but for a majority of the policy options the opposite is true (welfare
improving closures have too little support or vice versa)
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19. Motivation Model Calibration Calibration Results
Results preview
fiscal closure does matter
in short ...
... and long run
welfare may by improved (in Hicks sense) ...
... and with sufficient political support
but for a majority of the policy options the opposite is true (welfare
improving closures have too little support or vice versa)
Nishiyama & Smetters (2007) result is not universal
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20. Motivation Model Calibration Calibration Results
Outline
1 Motivation
2 Model
3 Calibration
4 Calibration
5 Results
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21. Motivation Model Calibration Calibration Results
Consumers I
live for j = 1, 2, ..., 16 periods
with survival probability πj,t < 1
choose labor supply endogenously until retirement at age ¯J
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22. Motivation Model Calibration Calibration Results
Consumers I
live for j = 1, 2, ..., 16 periods
with survival probability πj,t < 1
choose labor supply endogenously until retirement at age ¯J
Utility
u(cj,t, 1 − lj,t, gt) = log(cj,t) ← private consumption
+φl log(1 − lj,t) ← leisure
+φglog(gt) ← public goods consumption
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24. Motivation Model Calibration Calibration Results
Consumers II
Income is composed of
net labor income wj,t = (1 − τl,t)(1 − τt)ωj,t ¯wt
after-tax capital income rtaj,t = (1 − τk) ¯rtaj,t
unintended bequests Γj,t
pension benefits bj,t
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25. Motivation Model Calibration Calibration Results
Consumers II
Income is composed of
net labor income wj,t = (1 − τl,t)(1 − τt)ωj,t ¯wt
after-tax capital income rtaj,t = (1 − τk) ¯rtaj,t
unintended bequests Γj,t
pension benefits bj,t
and used to finance
consumption (1 + τc,t)cj,t
savings aj+1,t+1 − (1 + rt) aj,t
lump sum tax Υt
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26. Motivation Model Calibration Calibration Results
Consumers III
Ex ante homogeneous
with initial assets a1,t = 0 and productivity ω1,t = 1
Productivity changes randomly over time
ωj,t = eηj,t where ηj,t follows AR(1) process
approximated by Markov chain with Π(ηj,t|ηj−1,t−1)
States can be summarized by ψj,t = (aj,t, ηj,t, fj,t),
where aj,t denotes private assets, ηj,t productivity and fj,t pension assets
Solve the following optimization problem
V (ψj,t) = max
cj,t,lj,t,aj+1,t+1
u(cj,t, lj,t, gt) + δ
πj+1,t+1
πj,t
E V (ψj+1,t+1) | ψj,t
BC : aj+1,t+1 + (1 + τc,t)cj,t + Υt = wj,tlj,t + bj,t + (1 + rt) aj,t + Γj,t
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27. Motivation Model Calibration Calibration Results
Producers
Perfectly competitive representative firm
Standard Cobb-Douglas production function
Yt = Kα
t (ztLt)1−α
,
Profit maximization implies
wt = (1 − α)Kα
t zt(ztLt)−α
rt = αKα−1
(ztLt)1−α
− d
where d is the capital depreciation rate
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28. Motivation Model Calibration Calibration Results
Government
Collects taxes
Tt = τl,t(1 − τt) ¯wtLt + τk,trtAt + τc,tCt + Υt
J
j=1
Nj,t
Finances spending on public goods and service Gt = gt
J
j=1 Nj,t,
balance pension system subsidyt
and services debt ∆Dt = (1 + rt)Dt−1 − Dt
Tt = Gt + subsidyt + ∆Dt
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29. Motivation Model Calibration Calibration Results
Pension system
Baseline scenario PAYG DB
equal benefit for whole cohort (insurance motive)
b ¯J,t = ρ · wavg,t
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30. Motivation Model Calibration Calibration Results
Pension system
Baseline scenario PAYG DB
equal benefit for whole cohort (insurance motive)
b ¯J,t = ρ · wavg,t
indexed by payroll growth rate (labor ↑ ⇒ benefits ↑)
bj,t = (1 + rI
t )bj−1,t−1∀j > ¯J
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31. Motivation Model Calibration Calibration Results
Pension system
Baseline scenario PAYG DB
equal benefit for whole cohort (insurance motive)
b ¯J,t = ρ · wavg,t
indexed by payroll growth rate (labor ↑ ⇒ benefits ↑)
bj,t = (1 + rI
t )bj−1,t−1∀j > ¯J
longevity ↑ ⇒ deficit occurs
subsidyt =
J
j= ¯J
Nj,tbj,t − τtwt
¯J−1
j=1
Nj,tLt,
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32. Motivation Model Calibration Calibration Results
Pension system - reform: partially funded DC
contributions go into PAYG and funded pillar: τt = τI
t + τII
t
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33. Motivation Model Calibration Calibration Results
Pension system - reform: partially funded DC
contributions go into PAYG and funded pillar: τt = τI
t + τII
t
individual pension accounts fj,t = {fI
j,t, fII
j,t } ⇒ no insurance
fI
j,t = (1 + rI
t )fI
j−1,t−1 + τI
t wj,tlj,t
fII
j,t = (1 + ¯rt)fII
j−1,t−1 + τII
t wj,tlj,t
benefits are actuarially fair
b ¯J,t =
accrued ‘savings’
life expectancyt
+
accrued savings
life expectancyt
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34. Motivation Model Calibration Calibration Results
Pension system - reform: partially funded DC
contributions go into PAYG and funded pillar: τt = τI
t + τII
t
individual pension accounts fj,t = {fI
j,t, fII
j,t } ⇒ no insurance
fI
j,t = (1 + rI
t )fI
j−1,t−1 + τI
t wj,tlj,t
fII
j,t = (1 + ¯rt)fII
j−1,t−1 + τII
t wj,tlj,t
benefits are actuarially fair
b ¯J,t =
accrued ‘savings’
life expectancyt
+
accrued savings
life expectancyt
indexed by payroll growth rate and capital rate respectively
bI
j,t = (1 + rI
t )bI
j−1,t−1 and bII
j,t = (1 + ¯rt)bII
j−1,t−1 ∀j > ¯J,
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35. Motivation Model Calibration Calibration Results
64 policy options
8 ways of financing transition cost in baseline and reform scenario:
Fiscal closures within the pension system
contribution τt
tax on benefits τb,t
Fiscal closures financing the pension system deficit
consumption tax closure τc,t
labor tax τl,t
tax progressivity closure τH
l,tI
public debt + consumption tax Dt + τc,t
public debt + labor tax Dt + τl,t
public spending closure gt
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36. Motivation Model Calibration Calibration Results
Calibration to replicate 2015 US economy
Taxes {τc, τl, τk} match revenue as % of GDP {9.2%, 3.8%, 3.6%}
Depreciation rate d matches investment rate 25%
Replacement rate ρ matches benefits as % of GDP 5.2%
Contribution rate balances pension system
Retirement age ¯J = 65
Preference for leisure φl matches average hours 33%
Preference for public consumption φg optimal p.c value
Discounting rate δ matches interest rate 4%
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37. Motivation Model Calibration Calibration Results
Calibration of demographics
Demographics from UN data
number of 20-year-olds mortality rates
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38. Motivation Model Calibration Calibration Results
Calibration of demographics
Demographics from UN data
number of 20-year-olds mortality rates
Idiosyncratic productivity shock based on Kruger and Ludwig (2013):
Persistence η = 0.95
Variance ση = 0.375
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39. Motivation Model Calibration Calibration Results
Baseline
The effects of demographics
adjustment in pension parameters adjustment in fiscal parameters
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40. Motivation Model Calibration Calibration Results
Reform
Gradually replace PAYG DB with
a partially funded define contribution (DC)
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49. Motivation Model Calibration Calibration Results
Key insights
fiscal closure can change the evaluation of the reform
fiscal closure matters for political support
may improve welfare and be politically favored at the same time
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50. Motivation Model Calibration Calibration Results
Key insights
fiscal closure can change the evaluation of the reform
fiscal closure matters for political support
may improve welfare and be politically favored at the same time
labor supply major source of adjustment
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51. Motivation Model Calibration Calibration Results
Nishiyama & Smetters, 2007: stochastic vs deterministic?
large role for the insurance motive per se
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52. Motivation Model Calibration Calibration Results
Nishiyama & Smetters, 2007: stochastic vs deterministic?
large role for the insurance motive per se
but there are closures with positive outcomes despite stochastic setup
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54. Motivation Model Calibration Calibration Results
Conclusions
Fiscal closures matter a lot (unnoticed in earlier literature)
Insurance motive large but not decisive for evaluation of (partial)
privatization
Adjustment in pensions yields highest welfare, but is never politically
favored
Debt closures generally yield some welfare gain and are able to obtain
political support
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