welfare effects of fiscal closures when implementing pension reforms
DESCRIPTION
This presentation covers an analysis on how do fiscal closures matter for the welfare effects of implementing the pension reforms. We develop an OLG model and calibrate it to the case of actual reform implemented in Poland.TRANSCRIPT
Modeling the pension reforms
Macroeconomic modeling of the pension reforms1
Work in progress
Krzysztof Makarski 12 Joanna Tyrowicz234 Jan Hagemejer23
with the assistance of Agnieszka Borowska and Karolina GorausThe views expressed herein are those of the authors and not necessarily those of Narodowy Bank Polski
1Warsaw School of Economics2Faculty of Economics, University of Warsaw3Economic Institute, National Bank of Poland
4Rimini Center for Economic Analyses
Netspar - 2014 - Amsterdam1 / 40
Modeling the pension reforms
Motivation
The big(ger) pictureA (too) broad scientific project at the University of WarsawOLG modeling of the pension system reform in Poland(Our intended) Contributions:
1 fiscal closures have welfare effects (Pareto efficient reform?)2 labor market effects when intensive and extensive margin is combined
with indivisibility of labor3 political stability of pension reforms
We have (almost) completed (1), still work on (2) and (3)
Today: welfare effects of various fiscal closures for 1999 reform
2 / 40
Modeling the pension reforms
Motivation
The big(ger) pictureA (too) broad scientific project at the University of WarsawOLG modeling of the pension system reform in Poland(Our intended) Contributions:
1 fiscal closures have welfare effects (Pareto efficient reform?)2 labor market effects when intensive and extensive margin is combined
with indivisibility of labor3 political stability of pension reforms
We have (almost) completed (1), still work on (2) and (3)
Today: welfare effects of various fiscal closures for 1999 reform
2 / 40
Modeling the pension reforms
Motivation
The big(ger) pictureA (too) broad scientific project at the University of WarsawOLG modeling of the pension system reform in Poland(Our intended) Contributions:
1 fiscal closures have welfare effects (Pareto efficient reform?)2 labor market effects when intensive and extensive margin is combined
with indivisibility of labor3 political stability of pension reforms
We have (almost) completed (1), still work on (2) and (3)
Today: welfare effects of various fiscal closures for 1999 reform
2 / 40
Modeling the pension reforms
Motivation
The big(ger) pictureA (too) broad scientific project at the University of WarsawOLG modeling of the pension system reform in Poland(Our intended) Contributions:
1 fiscal closures have welfare effects (Pareto efficient reform?)2 labor market effects when intensive and extensive margin is combined
with indivisibility of labor3 political stability of pension reforms
We have (almost) completed (1), still work on (2) and (3)
Today: welfare effects of various fiscal closures for 1999 reform
2 / 40
Modeling the pension reforms
Motivation
Questions
How different fiscal closures of the pension system reform affectwelfare?
welfare effect of the reform (aggregate and across generations)?extent of fiscal adjustment for different fiscal closurespensionsmacroeconomic variables
What are the effects of changes proposed/implemented recently?additional welfare redistribution across cohortschanges to pensions and replacement ratesfiscal effect (debt/taxes) and capital
3 / 40
Modeling the pension reforms
Motivation
Questions
How different fiscal closures of the pension system reform affectwelfare?
welfare effect of the reform (aggregate and across generations)?extent of fiscal adjustment for different fiscal closurespensionsmacroeconomic variables
What are the effects of changes proposed/implemented recently?additional welfare redistribution across cohortschanges to pensions and replacement ratesfiscal effect (debt/taxes) and capital
3 / 40
Modeling the pension reforms
Model
Roadmap
1 Motivation
2 Model
3 Calibration
4 Welfare effects of fiscal closures
5 Summary
4 / 40
Modeling the pension reforms
Model
Model overviewOLG model with endogenous labor and savingsHeterogeneity across cohorts (mortality and labor productivity)No heterogeneity within cohortsAgents have time inconsistent preferencesExogenous retirement age and demographicsCompetitive producers with CD production functionPension system + pension system reformInter-generational transfers + utility to compare welfare across time withchanging demographicsDifferent fiscal closures (to do fiscal rules)Calibrated to the Polish economy
5 / 40
Modeling the pension reforms
Model
What we do not know before modeling?1999 reform: DB PAYG ⇒ NDC + FDC = partially funded DC
part of contributions stay in the PAYG system (SIF)part of contributions shifted away (OPFs) + fiscal tension todaylower replacement rates + ease fiscal tension in futurecomparing the steady states is not enough - transitory welfare effects
BUT SIF gap needs to be financed ⇒ possible fiscal closures with ownwelfare effects
five closures: lump sum, labor tax, consumption tax, debt + labor tax,debt + consumption taxwe cannot tell ex ante
which fiscal closure is better?effect for savings, labor supply and output?
6 / 40
Modeling the pension reforms
Model
What we do not know before modeling?1999 reform: DB PAYG ⇒ NDC + FDC = partially funded DC
part of contributions stay in the PAYG system (SIF)part of contributions shifted away (OPFs) + fiscal tension todaylower replacement rates + ease fiscal tension in futurecomparing the steady states is not enough - transitory welfare effects
BUT SIF gap needs to be financed ⇒ possible fiscal closures with ownwelfare effects
five closures: lump sum, labor tax, consumption tax, debt + labor tax,debt + consumption taxwe cannot tell ex ante
which fiscal closure is better?effect for savings, labor supply and output?
6 / 40
Modeling the pension reforms
Model
What we do not know before modeling?1999 reform: DB PAYG ⇒ NDC + FDC = partially funded DC
part of contributions stay in the PAYG system (SIF)part of contributions shifted away (OPFs) + fiscal tension todaylower replacement rates + ease fiscal tension in futurecomparing the steady states is not enough - transitory welfare effects
BUT SIF gap needs to be financed ⇒ possible fiscal closures with ownwelfare effects
five closures: lump sum, labor tax, consumption tax, debt + labor tax,debt + consumption taxwe cannot tell ex ante
which fiscal closure is better?effect for savings, labor supply and output?
6 / 40
Modeling the pension reforms
Model
What we do not know before modeling?1999 reform: DB PAYG ⇒ NDC + FDC = partially funded DC
part of contributions stay in the PAYG system (SIF)part of contributions shifted away (OPFs) + fiscal tension todaylower replacement rates + ease fiscal tension in futurecomparing the steady states is not enough - transitory welfare effects
BUT SIF gap needs to be financed ⇒ possible fiscal closures with ownwelfare effects
five closures: lump sum, labor tax, consumption tax, debt + labor tax,debt + consumption taxwe cannot tell ex ante
which fiscal closure is better?effect for savings, labor supply and output?
6 / 40
Modeling the pension reforms
Model
ConsumersAre free to choose how much to work, but only until J̄ (forced to retire)Optimize lifetime utility derived from leisure and consumption
Uj(cj,t, lj,t) = uj(cj,t, lj,t) + β
J−j∑s=1
δsπj+s,t+sπj,t
u (cj+s,t+s, lj+s,t+s) (1)
subject to
(1 + τc,t)cj,t + sj,t + τj + υt = (1− τ ιj,t − τl,t)wj,tlj,t ← labor income
+ (1 + rt(1− τk,t))sj,t−1 ← capital income+ (1− τl,t)pι,j,t + bj,t ← pensions + bequests
where u(c, l) = φ log(c) + (1− φ) log(1− l)
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Modeling the pension reforms
Model
Producersmaximize
Yt − wtLt − (rkt + d)Kt subject to Yt = Kαt (ztLt)
1−α
where the path of {z}∞t=0 is exogenous (calibrated to AWG, by EC)
Interest rate
interest rate on capital rkt = MPK − d, endogenous(riskless) interest rate on government debt to be rGt = 0.33 · rkthouseholds (and pension funds) by public debt inelasticallyreturns on savings yield a linear combination of risky and risk-less
8 / 40
Modeling the pension reforms
Model
Producersmaximize
Yt − wtLt − (rkt + d)Kt subject to Yt = Kαt (ztLt)
1−α
where the path of {z}∞t=0 is exogenous (calibrated to AWG, by EC)
Interest rate
interest rate on capital rkt = MPK − d, endogenous(riskless) interest rate on government debt to be rGt = 0.33 · rkthouseholds (and pension funds) by public debt inelasticallyreturns on savings yield a linear combination of risky and risk-less
8 / 40
Modeling the pension reforms
Model
Public financesSIF collects social security contributions and pays out pensions
subsidyt = τ ιt · wtLt −J∑j=J̄
bj,tπj,tNt−j (2)
any debt/surplus in SIF is government debt/surplus
Government
collects taxes on earnings, interest and consumption + υ
spends fixed amount of GDP/money + services debtlong run debt/GDP ratio fixedto finance pension system can use taxes or debt ⇐ fiscal closures
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Modeling the pension reforms
Model
Public financesSIF collects social security contributions and pays out pensions
subsidyt = τ ιt · wtLt −J∑j=J̄
bj,tπj,tNt−j (2)
any debt/surplus in SIF is government debt/surplus
Government
collects taxes on earnings, interest and consumption + υ
spends fixed amount of GDP/money + services debtlong run debt/GDP ratio fixedto finance pension system can use taxes or debt ⇐ fiscal closures
9 / 40
Modeling the pension reforms
Model
Pension systemsinitial steady state: PAYG Defined Benefit (DB), τ ιt = τDB
after the original reform: NDC + FDC (two pillars) τ = τ I + τ II
NDC = contributions indexed with growth of payroll + benefitactuarially fair + post retirement indexation with 20% of payroll growthFDC = contributions earn interest + benefit actuarially fair + postretirement also earn interest
10 / 40
Modeling the pension reforms
Model
Pension systemsinitial steady state: PAYG Defined Benefit (DB), τ ιt = τDB
after the original reform: NDC + FDC (two pillars) τ = τ I + τ II
NDC = contributions indexed with growth of payroll + benefitactuarially fair + post retirement indexation with 20% of payroll growthFDC = contributions earn interest + benefit actuarially fair + postretirement also earn interest
10 / 40
Modeling the pension reforms
Model
Pension systemsinitial steady state: PAYG Defined Benefit (DB), τ ιt = τDB
after the original reform: NDC + FDC (two pillars) τ = τ I + τ II
NDC = contributions indexed with growth of payroll + benefitactuarially fair + post retirement indexation with 20% of payroll growthFDC = contributions earn interest + benefit actuarially fair + postretirement also earn interest
10 / 40
Modeling the pension reforms
Model
Pension systemsinitial steady state: PAYG Defined Benefit (DB), τ ιt = τDB
after the original reform: NDC + FDC (two pillars) τ = τ I + τ II
NDC = contributions indexed with growth of payroll + benefitactuarially fair + post retirement indexation with 20% of payroll growthFDC = contributions earn interest + benefit actuarially fair + postretirement also earn interest
10 / 40
Modeling the pension reforms
Model
Solution method: Gauss-Seidel algorithmStart from the initial steady stateAssume the economy eventually achieves the new steady stateReform is unexpectedAlgorithm
Guess k per worker (or path) and compute wt, rtt = 0T
Compute individual choices (may need value functions).Aggregate to get new k
′(or path)
If |k − k′ | < err finishJust in case ... check feasibility
No contraction mapping theorem
11 / 40
Modeling the pension reforms
Model
Solution method: Gauss-Seidel algorithmStart from the initial steady stateAssume the economy eventually achieves the new steady stateReform is unexpectedAlgorithm
Guess k per worker (or path) and compute wt, rtt = 0T
Compute individual choices (may need value functions).Aggregate to get new k
′(or path)
If |k − k′ | < err finishJust in case ... check feasibility
No contraction mapping theorem
11 / 40
Modeling the pension reforms
Model
Solution method: Gauss-Seidel algorithmStart from the initial steady stateAssume the economy eventually achieves the new steady stateReform is unexpectedAlgorithm
Guess k per worker (or path) and compute wt, rtt = 0T
Compute individual choices (may need value functions).Aggregate to get new k
′(or path)
If |k − k′ | < err finishJust in case ... check feasibility
No contraction mapping theorem
11 / 40
Modeling the pension reforms
Model
Solution method: Gauss-Seidel algorithmStart from the initial steady stateAssume the economy eventually achieves the new steady stateReform is unexpectedAlgorithm
Guess k per worker (or path) and compute wt, rtt = 0T
Compute individual choices (may need value functions).Aggregate to get new k
′(or path)
If |k − k′ | < err finishJust in case ... check feasibility
No contraction mapping theorem
11 / 40
Modeling the pension reforms
Model
How do we know what is "better"? LSRA!Lump Sum Redistribution Authority as Nishiyama & Smetters (2007)
1 Run the no policy change scenario ⇒ baseline2 Run the policy change scenario ⇒ reform3 For each cohort compare utility, compensate the losers from the winners4 If net effect positive ⇒ reform efficient5 Run reform again, with the compensation, to observe GE effects
What is baseline?
Always the same: births, mortality, productivity and retirement age1999 Reform: baseline = PAYG DB | reform = NCD + FDC
12 / 40
Modeling the pension reforms
Model
How do we know what is "better"? LSRA!Lump Sum Redistribution Authority as Nishiyama & Smetters (2007)
1 Run the no policy change scenario ⇒ baseline2 Run the policy change scenario ⇒ reform3 For each cohort compare utility, compensate the losers from the winners4 If net effect positive ⇒ reform efficient5 Run reform again, with the compensation, to observe GE effects
What is baseline?
Always the same: births, mortality, productivity and retirement age1999 Reform: baseline = PAYG DB | reform = NCD + FDC
12 / 40
Modeling the pension reforms
Model
How do we know what is "better"? LSRA!Lump Sum Redistribution Authority as Nishiyama & Smetters (2007)
1 Run the no policy change scenario ⇒ baseline2 Run the policy change scenario ⇒ reform3 For each cohort compare utility, compensate the losers from the winners4 If net effect positive ⇒ reform efficient5 Run reform again, with the compensation, to observe GE effects
What is baseline?
Always the same: births, mortality, productivity and retirement age1999 Reform: baseline = PAYG DB | reform = NCD + FDC
12 / 40
Modeling the pension reforms
Calibration
Roadmap
1 Motivation
2 Model
3 Calibration
4 Welfare effects of fiscal closures
5 Summary
13 / 40
Modeling the pension reforms
Calibration
Baseline: no of births (20 year olds):Demographic projection (2060), constant afterwards (conservative)
14 / 40
Modeling the pension reforms
Calibration
Baseline: mortality ratesDemographic projection (2060), constant afterwards
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Modeling the pension reforms
Calibration
Baseline: old age dependency ratioDemographic projection (2060), constant afterwards
16 / 40
Modeling the pension reforms
Calibration
Baseline: labor augmenting technological progressHistorical data, projection from AWG, new steady state at 1.7%
17 / 40
Modeling the pension reforms
Calibration
Baseline: retirement ageHistorical data, assumed (based on law) afterwards
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Modeling the pension reforms
Calibration
Baseline (outcomes): pension benefits in GDPAging plus decreasing labor force
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Modeling the pension reforms
Calibration
Calibration to replicate 1999 economyPreference for leisure (φ) matches participation rate of 56.8%Replacement rate (ρ) matches benefits/GDP ratio of 5%Contributions rate (τ) matches SIF deficit/GDP ratio of 0.8%Labor income tax (τl) set to 11% to match PIT/GDP ratioConsumption tax (τc) set to match VAT/GDP ratioCapital tax (τk) de iure = de factoThe initial capital
20 / 40
Modeling the pension reforms
Calibration
Life cycle productivity: flat or Deaton (1997)
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Modeling the pension reforms
Calibration
Parameters for different calibrations
Calibrated parameters
β = 1 β = 0.9 β = 0.8ω = 1 ω - D97 ω = 1 ω - D97 ω = 1 ω - D97
φ 0.535 0.577 0.537 0.575 0.538 0.578δ 0.981 1.007 0.986 1.005 0.993 1.012d 0.052 0.055 0.057 0.055 0.055 0.06tl 0.11 0.11 0.11 0.11 0.11 0.11τ 0.061 0.0608 0.0608 0.061 0.0606 0.0611ρ 0.25 0.15 0.25 0.15 0.251 0.151
resultingxt/yt 21.1 21.1 21.1 21.1 21.1 21.1r 7.5 7.3 7.5 7.5 7.5 7.3
Note: D97: Deaton (1997) decomposition.
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Modeling the pension reforms
Welfare effects of fiscal closures
Roadmap
1 Motivation
2 Model
3 Calibration
4 Welfare effects of fiscal closures
5 Summary
23 / 40
Modeling the pension reforms
Welfare effects of fiscal closures
Results
SIF deficit resulting from the reform is financed ...
... by labor tax or consumption tax
⇒ debt share in GDP is held constant, so are taxes, but τl or τc is adjustedamong all the living
... by debt which is later repaid with labor or consumption tax
⇒ debt share in GDP grows to a threshold of 70%, with all taxes heldconstant, then debt gets automatically reduced to 45% of GDPexponentially, τc or τl is adjusted for living then onwards
... by lump sum taxes on all living generations
⇒ debt share in GDP and tax rates are held constant, υ is adjusted amongall the living
24 / 40
Modeling the pension reforms
Welfare effects of fiscal closures
Results
SIF deficit resulting from the reform is financed ...
... by labor tax or consumption tax
⇒ debt share in GDP is held constant, so are taxes, but τl or τc is adjustedamong all the living
... by debt which is later repaid with labor or consumption tax
⇒ debt share in GDP grows to a threshold of 70%, with all taxes heldconstant, then debt gets automatically reduced to 45% of GDPexponentially, τc or τl is adjusted for living then onwards
... by lump sum taxes on all living generations
⇒ debt share in GDP and tax rates are held constant, υ is adjusted amongall the living
24 / 40
Modeling the pension reforms
Welfare effects of fiscal closures
Results
SIF deficit resulting from the reform is financed ...
... by labor tax or consumption tax
⇒ debt share in GDP is held constant, so are taxes, but τl or τc is adjustedamong all the living
... by debt which is later repaid with labor or consumption tax
⇒ debt share in GDP grows to a threshold of 70%, with all taxes heldconstant, then debt gets automatically reduced to 45% of GDPexponentially, τc or τl is adjusted for living then onwards
... by lump sum taxes on all living generations
⇒ debt share in GDP and tax rates are held constant, υ is adjusted amongall the living
24 / 40
Modeling the pension reforms
Welfare effects of fiscal closures
Results: Welfare
Efficiency of the reforms
baseline closurereform closure Υ τc τl debt + τc debt + τl
Υ 2.0% 2.4% 2.6% 2.3% 2.5%τc 1.7% 2.0% 2.2% 1.9% 2.1%
debt + τc 1.7% 2.1% 2.3% 2.0% 2.2%τl 1.5% 1.9% 2.1% 1.8% 2.0%
debt + τl 1.6% 2.0% 2.2% 1.9% 2.1%
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Welfare
LSRA after redistribution (% of perm. cons.)
Fiscal β = 1 β = 0.9 β = 0.8closure flat D97 flat D97 flat D97τl 0.021 0.016 0.015 0.012 0.009 0.005Debt/τl 0.021 0.015 0.015 0.012 0.009 0.005τC 0.020 0.017 0.015 0.012 0.009 0.006Debt/τC 0.020 0.016 0.014 0.012 0.008 0.005υt 0.020 0.019 0.015 0.013 0.011 0.007
Note: D97 denotes calibration according to Deaton (1997) decomposition.
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Fiscal adjustment
Debt/consumption tax - higher taxes initially, becomeeventually lower
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Fiscal adjustment
Debt/labor tax - higher taxes initially, become eventuallylower
28 / 40
Modeling the pension reforms
Welfare effects of fiscal closures
Results: Fiscal adjustment
Labor tax - higher taxes initially, become eventually lower
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Fiscal adjustment
Consumption tax - higher taxes initially, become eventuallylower
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Fiscal adjustment
Extent of fiscal adjustment - lump sum tax
Higher taxes initially, become lower after a while.Note; lump sum taxes have real effects (redistribution)
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Pensions
Replacement rates - relative to baselinePensions are substantially reduced by PAYG DB → DCFiscal closure matters littleInitial cohorts unaffected
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Macroeconomic effects
Closure GDP Labor supply CapitalPeriod D97 ω flat ω D97 ω flat ω D97 ω flat ω10 0.6% 0.7% -0.9% -0.5% 1.8% 2.3%
Labor tax 50 2.2% 2.0% -1.3% 0.9% 7.2% 6.4%∞ 2.5% 2.1% -1.2% 0.4% 8.3% 7.0%10 0.6% 0.7% -0.8% -0.2% 1.9% 2.4%
Consumption 50 2.9% 2.7% -0.6% 1.1% 9.8% 9.1%tax ∞ 2.4% 2.0% -0.9% 0.5% 7.8% 6.7%
10 0.2% 0.2% -0.3% 0.1% 0.6% 0.5%Debt with 50 2.0% 1.8% -1.1% 1.1% 6.7% 5.8%τl ∞ 2.5% 2.1% -1.2% 0.4% 8.3% 7.0%
10 0.2% 0.1% -0.4% 0.1% 0.6% 0.4%Debt with 50 3.0% 2.8% -0.5% 1.1% 10.0% 9.2%τl ∞ 2.3% 2.0% -0.9% 0.5% 7.8% 6.7%
10 0.5% 0.6% -0.2% 0.4% 1.7% 2.1%Lump sum 50 2.2% 2.0% -1.9% -0.5% 7.3% 6.7%tax ∞ 2.6% 2.0% -2.3% -0.5% 8.5% 6.6%
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Distribution of welfare effects
Welfare: all closures, no time inconsistency
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Decomposition of welfare effects
Decomposition - consumption tax (left) anddebt/consumption tax (right)
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Decomposition of welfare effects
Decomposition - labor tax (left) and debt/labor tax (right)
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Time inconsistency
Time inconsistency - matters little for capitalCapital - consumption tax closure and debt closure with consumption tax
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Modeling the pension reforms
Welfare effects of fiscal closures
Results: Time inconsistency
Time inconsistency - preserves the general findingsWelfare - consumption tax closure and debt with consumption tax closure
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Modeling the pension reforms
Summary
Roadmap
1 Motivation
2 Model
3 Calibration
4 Welfare effects of fiscal closures
5 Summary
39 / 40
Modeling the pension reforms
Summary
Generally, 1999 reform is welfare enhancing
Overall effects positive
Majority comes from DB->DC changeFiscal closure matters for (cohort) composition effectsPensions fall which implies that considerable redistribution acrosscohorts neededIntroduction of funded DC makes debt desirable (redistributes)
To do
Log utility: taxes affect labor marginally (GHH preferences)Endogenous retirement
40 / 40
Modeling the pension reforms
Summary
Generally, 1999 reform is welfare enhancing
Overall effects positive
Majority comes from DB->DC changeFiscal closure matters for (cohort) composition effectsPensions fall which implies that considerable redistribution acrosscohorts neededIntroduction of funded DC makes debt desirable (redistributes)
To do
Log utility: taxes affect labor marginally (GHH preferences)Endogenous retirement
40 / 40