1. Public Finance - Introductory
Pensions systems
Public Finance - Introductory

2. Pensions: stylized facts
In most countries the largest source of public spending → often between 14% e il 17%
Upward trend because of
Demographics
Misuse of early pensions instead of unemployment insurance/assistance
Several types of pensions
Old age : when beyond a certain age
(Early) Retirement : when beyond a certain # of years of work
Disability : for ind who cannot earn an income because of accident/illness
Survivors : for relatives of deceased workers
Social : for ind non self sufficient
Family : for families with dependent children
1-2 social insurance → previdence
3-6 → assistance
Sociale, di guerra, invalidi civili, non udenti, non vedenti: assistenza (relaz gen 07)
Public Finance - Introductory

3. Rationales for government intervention
Efficiency
Asymmetric info (weak)
Intergenerational insurance
Negative externality
Equity
Merit good
Solidarity between generations
Public Finance - Introductory

4. Public Finance - Introductory
Evolution
XIX century: mutual assistance within working categories
XX century: progressive extension of mandatory insurance
Growth of SS spending due to extension of provisions
Since the 1980s many countries face a ‘pension debt’ → difference between entitled provisions and PV of future SS contributions
→ pension crises
3 causes of pension debt
Financing mechanism of SS institutions
Macroeconomic situation
Demografics
Public Finance - Introductory

5. Public Finance - Introductory
U.S. historical data
Public Finance - Introductory

6. Public Finance - Introductory
The record braker
Ida Mae Fuller
First recipient of monthly Social Security Benefits
Retired Nov. 4, 1939 and died in 1975, aged 100
Collected US$20,897 SS benefits having paid a tax of US$24.85
Public Finance - Introductory

7. Expenditures in SS - % of GDP – OECD 2006
Public Finance - Introductory

8. Sustainability of pensions in France – COR alternative scenarios
Public Finance - Introductory

9. Causes of pensions crises
In most countries, pension schemes were originally fully funded (capitalization)
USA was an exception due to Great Depression → PAYG a fundamental element of Roosevelt’s New Deal
High inflation of the 1970s reduced the real value of pension savings → switch to pay as you go PAYG
Beginning with the 1980s increase of life expectancy and reduction of participation to workforce reduced the amount of contributions → pension debt
Public Finance - Introductory

10. Definition of amount of pensions
2 ways of calculating the amount of the pension
Retribution: pension correlated with salary (average or of the last X years)
Contribution: pension correlated with contributions actually set aside
In most countries until the 1990s predominance of retribution schemes
→ Pension debt
→ Differences of treament between categories of workers
→ Confusion between previdence and assistance
Progressive switch to contribution systems with reforms during the 1990s
Public Finance - Introductory

11. Public Finance - Introductory
Financing
Repartition (pay-as-you-go, or PAYG)
Fully funded (capitalization)
Non fully-funded: mix of the two previous systems (typical of countries undergoing pension reforms)
Public Finance - Introductory

12. Public Finance - Introductory
Pay-as-you-go
Revenues of contributions at time t finance pensions at t
→ Today’s workers pay pensions of today’s retirees
Equilibrium requires contributions=outlays at every time
Public Finance - Introductory

13. Public Finance - Introductory
Capitalization
Also called ‘fully-funded’ because it is their main feature
Today’s contributions invested in capital markets
Upon retirement pension is equal to total amount of contributions plus total amount of capital gains/losses
Equilibrium requires contributions=social security tax+rates of return=investiments+matured interest
Public Finance - Introductory

14. Public Finance - Introductory
Fully Funded Plan
Period 1
Period 2
Period 3
Period 4
The Greatest
Generation
Work
Retire
Dead
Still Dead
contribute
benefits
Each generation’s benefits based on deposits it made during working life plus accumulated interest
The Baby Boom
Generation
Retire
Childhood
Work
Dead
contribute
benefits
Unborn
Childhood
Work
Retire
Generation X
contribute
benefits
Public Finance - Introductory

15. Pay As You Go (or Unfunded) System
Pay As You Go (or Unfunded) System
Period 1
Period 2
Period 3
Period 4
Each generation’s benefits come from tax payments made by current workers
contribute
benefits
The Greatest
Generation
Work
Retire
Dead
Still Dead
contribute
benefits
The Baby Boom
Generation
Work
Retire
Childhood
Dead
contribute
benefits
Unborn
Childhood
Work
Retire
Generation X
benefits
Public Finance - Introductory

16. Partially Funded System
Partially Funded System
Period 1
Period 2
Period 3
Period 4
contribute
benefits
Baby Boomers and Gen X are also contributing to their own retirement
The Greatest
Generation
Work
Retire
Dead
Still Dead
contribute
benefits
The Baby Boom
Generation
Work
Retire
Childhood
Dead
contribute
benefits
Unborn
Childhood
Work
Retire
Generation X
benefits
Public Finance - Introductory

17. Comparison between capitalization and PAYG
PAYG generates intergenerational transfers
Capitalization generates intertemporal reallocation
If interest rate equal to productivity growth rate+rate of change of workforce → they are equivalent
Public Finance - Introductory

18. Pensions and redistribution - 1
The more a pension scheme is …
PAYG
Retributive
…the greater its redistributive potential
The larger the outlays, the greater the redistribution
Redistribution fluxes between generations (young and old) → intergenerational pact
Under fully funded system → inter-temporal redistribution, no intergenerational pact
Public Finance - Introductory

19. Pensions and redistribution - 2
In PAYG systems redistribution depends on equilibrium SS tax rate → ratio contributions/wage can avoid pension debt
Type of redistribution (“intergenerational pact”) depends on 3 features of the system, i.e., whether it is in fixed amount:
Substitution rate between pension and retribution
Ratio between total pensions/total salaries
Ratio between pension pro capite and net (of contributions ) wage
Public Finance - Introductory

20. 1. Fixed rate of substitution
Pension is a fixed % of last year’s salary (or of the average of the last years)
If population decreases → financial equilibrium requires higher SS tax rate
Redistribution from young to old (lower net wage)
If productivity rises → financial equilibrium requires lower SS tax rate
Redistribution from old to young (higher net wage)
Public Finance - Introductory

21. 2. Fixed ratio total pensions/total salaries
If equilibrium is kept at the aggregate level (total of contributions paid by all workers=total of pensions paid to all retirees)
If population growth slows down → reduces today’s pensions (and viceversa)
If productivity growth increases → increases today’s pensions and today’s net salaries (and viceversa)
Public Finance - Introductory

22. 3. Fixed ratio pension/net wage
If equilibrium is at the level of single pension and single net wage
If population growth slows down → it raises the equilibrium SS tax rate and reduces both the net wage and today’s pensions
Same for productivity growth slowdown
In general “…the devil lies in the details”
In many countries (Italy, France) important fluxes of redistribution among categories of workers
Pension jungle
This is what current reform in France is surely goinjg to produce
Public Finance - Introductory