RISK SHARING AND EFFICIENCY IMPLICATIONS

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1 IMPLICATIONS OF PROGRESSIVE PENSION ARRANGEMENTS UNIVERSITY OF WUERZBURG

2 CONTENTS 1/18 CONTENTS 1. MOTIVATION 2. THE NUMERICAL GENERAL EQUILIBRIUM MODEL 3. SIMULATION RESULTS 4. CONCLUSIONS

3 MOTIVATION 2/18 MOTIVATION Fenge (1995): Question: First answer: Here: Intragenerational fair paygo system is Pareto-efficient! Why do we observe progressive pension systems in many countries? Progressivity is determined by the voting outcome (Casamatta et al., 2000 or Conde-Ruiz and Galasso, 2005). Pension progressivity is efficient due to it s insurance properties!

Why do we observe progressive pension systems in many countries?

4 MOTIVATION 3/18 Net replacement rates by Basic individual earnings level allowance Multiple of average in % of average wage Germany a Italy Netherlands Poland Spain Australia France Ireland Japan UK USA a currently proposed

1 83.8 Poland 69.6 69.7 70.5 Spain 88.7 88.3 83.4 Australia 77.0 52.4 36.5 France 98.0 68.8 59.

5 MOTIVATION 4/18 RELATED LITERATURE Pension reforms: Huggett/Ventura (1999), Støresletten et al. (1999), De Nardi et al. (1999), Conesa/Krueger (1999). Income tax reforms: Conessa/Krueger (2004), Smetters/Nishiyama (2003).

6 THE NUMERICAL GENERAL EQUILIBRIUM MODEL 5/18 THE NUMERICAL GENERAL EQUILIBRIUM MODEL Households work for 8 periods (i.e. 40 years) and can live up to 16 periods (i.e. up to age 100), Liquidity constraints, unintended bequest; Closed economy without population ageing; Cobb-Douglas production function with capital and labor, Government issues debt and levies progressive income taxes, corporate taxes and adjusts consumption taxes endogenously.

bequest; Closed economy without population ageing; Cobb-Douglas production function with capital and labor,

7 THE NUMERICAL GENERAL EQUILIBRIUM MODEL 6/18 V j (z) = max l j,c j INDIVIDUAL DECISIONS u(c j,l j ) 1 1 γ + s j+1 1+θ π(e j+1 e j )V j+1 (z ) 1 η ej γ 1 η γ State variables: z =(ep j,a j,e j ) earning points, assets, and productivity Budget constraint: a j+1 = a j (1 + r)+(1 l j )we } {{ } j (1 τ j )+p j T (y j ) (1 + τ c )c j + b j w j

variables: z =(ep j,a j,e j ) earning points, assets, and productivity Budget

8 THE NUMERICAL GENERAL EQUILIBRIUM MODEL 7/18 MODELLING OF FLAT BENEFITS AND BASIC ALLOWANCES Computation of earning points at age j: ep j = ep j 1 +min[w j / w;2.0] (1 λ)+λ Computation of individual pension at age j j R : p j = ep jr AP A Computation of individual contribution rate τ j : 0 if w j <β w, τ j = τ[w j β w]/w j if β w w j 2.0 w, τ[2.0 β] w/w j if w j > 2.0 w.

0] (1 λ)+λ Computation of individual pension at age j j R : p j = ep jr AP A Computation of

9 THE NUMERICAL GENERAL EQUILIBRIUM MODEL 8/18 CALIBRATION: THE INCOME PROCESS Table 1: Markov transition matrix Current productivity level Past productivity level Source: Authors own calculations from 1998/2003 SOEP data

02 Past 3 0.08 0.13 0.41 0.24 0.10 0.04 productivity 4 0.06 0.03 0.19 0.39 0.25 0.08 level 5 0.04 0.02 0.

10 SIMULATION RESULTS 9/18 Table 2: The initial equilibrium Model Germany 2003 pension benefits (in % of GDP) pension contribution rate (in %) Tax revenues (in % of GDP) income tax consumption tax corporation tax consumption tax rate (in %) 18.0 interest rate p.a. (in %) 3.1 capital-output ratio *Source: Institut der deutschen Wirtschaft (2004).

7 income tax 7.7 7.4 consumption tax 11.4 10.7 corporation tax 1.8 1.7 consumption tax rate (in %) 18.

11 SIMULATION RESULTS 10 / 18 Model Table 3: Income and Wealth Distribution Percentage shares Gini Lowest 10% Highest 10% index Net income Assets Net income Germany Assets * Source: DIW (2005, 202)

index Net income 3.4 22.2 0.287 Assets 0.0 30.4 0.

12 SIMULATION RESULTS 11 / 18 Table 4: Macroeconomic effects of progressive pensions (β =0.3,λ =0.5) Period Employment Capital stock Wage a Contribution rate Consumption tax

5) Period 2005-09 2025-29 2045-49 Employment -5.2-4.1-4.

13 SIMULATION RESULTS 12 / 18 Figure 1: Welfare effects of progressive pensions! ) L A H = C A 9 A B= H A + D = C A I E! ' '! # ' $ ' & #! # ; A = H B* EH JD 9 EJD K J 5 4 ) 9 EJD 5 4 )

14 SIMULATION RESULTS 13 / 18 Table 5: Compensated welfare changes: Benchmark β λ In percentage of remaining resources.

1 0.69 1.12 1.43 1.64 1.61 0.2 1.37 1.76 2.04 2.05 2.06 0.3 1.73 2.00 2.

15 SIMULATION RESULTS 14 / 18 DISAGGREGATING THE EFFICIENCY GAIN Sensitivity Analysis: Insurance + liquidity + labor supply effect } {{ } } {{ 1.49 } } {{ 1.00 } 2.13 γ : (Liquidity effect ) ρ : (Labor supply effect ) η : (Insurance effect )

{{ } } {{ 1.49 } } {{ 1.00 } 2.13 γ : 0.5 0.25 2.

16 SIMULATION RESULTS 15 / 18 Figure 2: Voting without increasing debt 2 H. H =? JE B+ D H JI 8 JA H I & $ " ' ' '! ' " ' # ' $ ' % ' & ; A = H B* EH JD 2 H. H =? JE B+ D H JI 2 H. H =? JE B8 JA H I

17 SIMULATION RESULTS 16 / 18 Figure 3: Welfare effects with increasing debt " ) L A H = C A 9 A B= H A + D = C A I E!! ' '! # ' $ ' & #! # ; A = H B* EH JD 9 EJD K J 5 4 ) 9 EJD 5 4 )

18 SIMULATION RESULTS 17 / 18 Figure 4: Voting with increasing debt 2 H. H =? JE B+ D H JI 8 JA H I & $ " ' ' '! ' " ' # ' $ ' % ' & ; A = H B* EH JD 2 H. H =? JE B+ D H JI 2 H. H =? JE B8 JA H I

19 CONCLUSIONS 18 / 18 CONCLUSIONS Tax-benefit linkage of the German pension system should be reduced! Result is robust and reinforced by sensitivity analysis! However, such a reform will not find political support! Future work: pension privatization; optimal progressivity of tax and pension system; mandatory vs. voluntary retirement accounts;

However, such a reform will not find political support!

Private Retirement Savings in Germany - Structure of Tax Incentives and Annuitization

Private Retirement Savings in Germany: The Structure of Tax Incentives and Annuitization HANS FEHR CHRISTIAN HABERMANN CESIFO WORKING PAPER NO. 2238 CATEGORY 1: PUBLIC FINANCE MARCH 2008 An electronic