EC3060 Economics of Policy Issues 1 Economics of Policy Issues EC3060 Autumn 2015 Case Study: Irish Pension System and Challenges Michael King

EC3060 Economics of Policy Issues 2 Additional Readings Supplementary National Pensions Framework (2010) pdf pdf OECD Review of Irish Pension System review-of-the-irish-pensions-system.pdf review-of-the-irish-pensions-system.pdf

EC3060 Economics of Policy Issues 3 The Entitlement to Income during Old Age Entitlements provided during old age are important for: –Older people who benefit –Younger people who pay An intergenerational social contract: We begin from conditions of a hunter–gatherer society –The old can survive only if the young give them food

EC3060 Economics of Policy Issues 4 Unborn generations are not present when the social contract is set out The intergenerational contract is Pareto- improving Abrogating the contract of intergenerational transfers would make every generation worse off

EC3060 Economics of Policy Issues 5 A government collectivizes the intergenerational income transfers: –Most Common: Under a pay-as-you-go scheme, taxes paid by working generations finance the consumption of retired generations –Ideal Situation: Fully funded systems each individual covers own future cost Without compulsory payments collective transfer from the young productive population to retired people introduces free-riding incentives Compulsory taxes during productive years preempt such free-rider behaviour.

EC3060 Economics of Policy Issues 6 Sustainability of intergenerational income transfers –The dependency ratio excluding children –The number of people in the retired generation = n R –The number of people working = n W The dependency ratio is:

EC3060 Economics of Policy Issues Case Study: The Pension Crisis Short Video: Elderly Fuel Povertyhttps:// MExFshttps:// MExFs How will your generation solve the looming pension crisis? How will you vote?

EC3060 Economics of Policy Issues Elderly Poverty in Ireland (2011) 8 Elderly poverty in Ireland did fall significantly in the boom years – greater social expenditure. Elderly poverty in Ireland is real. In 2011: –10% suffer from low incomes –11% suffer from deprivation –19% suffer from low incomes or deprivation.

EC3060 Economics of Policy Issues Future: The Perfect Storm 1.The greying of Ireland –Increased life expectancy –Lower birth rates 2.Cost of elderly care –Increasing medical costs –Increasing costs of old age care 3.Failure of private pension provision –Insufficient pension coverage –Lack of private savings 9 Increased old age dependency rate α

EC3060 Economics of Policy Issues 10 1.The greying of Ireland –Increased life expectancy –Lower birth rates The number of people in the retired generation = n R The number of people working = n W This dependency rate excludes children Increased old age dependency rate α

EC3060 Economics of Policy Issues 11

EC3060 Economics of Policy Issues 12 Old Age Dependency Rates

EC3060 Economics of Policy Issues 2.Cost of elderly care –Increasing medical costs –Increasing costs of care 13

EC3060 Economics of Policy Issues 14 3.Failure of private provision –Insufficient pensions coverage

EC3060 Economics of Policy Issues 15 Long term fiscal implications Note: By OECD standards Ireland already has a low minimum government pension rate but it will be costly to maintain.

EC3060 Economics of Policy Issues 16 The Battle of the Generations: What will you vote for? What will you vote for: 1.Increase significantly taxes on working age population (to maintain state pension or massively subsidise private savings) 2.Reduce significantly other expenditure: social expenditure (health, education) or expenditure on infrastructure 3.Reduce significantly state pension 4.Increase significantly eligibility age 5.Combinations of the four.

EC3060 Economics of Policy Issues How long will you live? rl/CalcForm.html Results Life Expectancy: years Lower Quartile: years (75% chance you will live longer) Upper Quartile: years (25% chance you will live longer) Resources Needed 20 €30,000 p.a. = €600,000 Only have 30 years to raise this – assuming minimal growth need to save approx. €18,000 per year. 17

EC3060 Economics of Policy Issues How long will you live? rl/CalcForm.html Results Life Expectancy: years (RIP: April 2065) Lower Quartile: years (75% chance you will live longer) Upper Quartile: years (25% chance you will live longer) Resources Needed 20 €30,000 p.a. = €600,000 Only have 30 years to raise this – assuming minimal growth need to save approx. €18,000 per year. 18

EC3060 Economics of Policy Issues How long will you live? rl/CalcForm.html Results Life Expectancy: years (RIP: April 2065) Lower Quartile: years (75% chance you will live longer) Upper Quartile: years (25% chance you will live longer) Resources Needed 20 €30,000 p.a. = €600,000 Only have 30 years to raise this – assuming minimal growth need to save approx. €18,000 per year.  Consider how you will provide for you golden years early and often! The Life Cycle Hypothesis! 19

EC3060 Economics of Policy Issues 20 Irish Pension System Overview: The Three Pillars Pillar I: Flat rate partly funded PAYG system In 2005 €219 per week represents Pillar II: voluntary private pension system - Occupational and private schemes ½ the workforce 72bn in Pillar III: Non-pension wealth earnings, investment income etc Unequally distributed 70% of net personal sector wealth in UK

EC3060 Economics of Policy Issues 2015 State Pension Rates 21

EC3060 Economics of Policy Issues 22 Pillar 1 Income Replacement Rates

EC3060 Economics of Policy Issues 23 Summary of Irish System Pillar 1 comprises of two parts –a basic minimum safety net based on needs assessment –a contributory pension, where value is linked to the level of PSRI paid Pillar 1 pensions provide low income replacement rates - defining characteristic of the Irish system

EC3060 Economics of Policy Issues 24 Pillar 2: Private Pensions At the end of 2005, only 52.6% of the labour force possessed private pensions. –considerably below the target set out in the 1998 NPPI report of 70%. –Projections of the coverage rate indicate that without policy action the private pension coverage rate will only rise from 52.6% in 2006 to 54.5% in Favorable tax arrangements to encourage the growth of the private voluntary pension system. Tax reliefs are currently available on: –employers and employees contributions –on the investment income –the capital gains of the funds –lump sum on retirement

EC3060 Economics of Policy Issues 25 Failure of private provision –Lack of private savings Replacement Rate of 0.5: There is also widespread pension savings insufficiency with an estimated shortfall of €3,300 per annum per worker (2004).

EC3060 Economics of Policy Issues Evolution of retirement age 26

EC3060 Economics of Policy Issues 27 Summary of Challenges

EC3060 Economics of Policy Issues 28 Irish Pensions Framework 2010: Highlights Seek to maintain the value of the State Pension at 35 per cent of average weekly earnings. Apply credits rather than disregards to homemakers and backdate these to 1994 for new pensioners from Introduce a standard age of 66 for the State Pension from 2014 and gradually increase state pension age to 68 by 2028.

EC3060 Economics of Policy Issues 29 Irish Pensions Framework 2010: Highlights Proposed new auto-enrolment system private pensions scheme are as follows: –Employees (aged 22 or over) will be automatically enrolled unless they are a member of their employer’s scheme (which provides higher contribution levels or is a DB scheme). –Employees will be required to make a fixed percentage contribution. –There will be a State contribution equal to 33 per cent tax relief and employer contributions to match the State contribution. –Once-off bonus payment for people who remain in the scheme for more than five years continuously. Current tax relief for contributions to existing occupational and personal pension arrangements will be replaced by a State contribution equal to 33 per cent tax relief.

EC3060 Economics of Policy Issues Budget 2011: Private Pensions 1.Private pension contributions will no longer be able to claim relief from Pay Related Social Insurance (PRSI) and the universal social charge. (Savings = €150 million in a full year) 2.Signaled further reductions in the tax relief on private pensions. 3.In  There is a limit on the earnings that may be taken into account. The limit is €115,000.  The older you are the amount of your earnings that qualify for tax relief increases.