Does social security reform reduce gains from higher retirement age?

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<p> 1. The shadow of longevity - does social security reform reduce gains from increasing the retirement age? Karolina Goraus 3 Krzysztof Makarski 1 2 Joanna Tyrowicz 1 3 1 Narodowy Bank Polski 2 Warsaw School of Economics 3 Warsaw University Agenta Workshop June 2015 1 / 32 2. Table of contents 1 Motivation and insights from literature 2 Model setup 3 Baseline and reform scenarios 4 Calibration 5 Results 2 / 32 3. Motivation and insights from literature Motivation Major issues in pension economics: increasing old-age dependency ratio majority of pension systems fail to assure actuarial fairness in most countries people tend to retire as early as legally allowed Typical reform proposals switch to DC systems and strengthen the link between contributions and benets raise the social security contributions cut government expenditure or ... increasing minimum eligibility retirement age (MERA) 3 / 32 4. Motivation and insights from literature Literature review Two streams of literature: 1 Answering the question about optimal retirement age (Gruber and Wise (2007), Galasso (2008), Heijdra and Romp (2009)) 2 Comparing dierent pensions system reforms: increasing retirement age vs. cut in benets/privatization of the system/... (Auerbach et al. (1989), Hviding and Marette (1998), Fehr (2000), Boersch-Supan and Ludwig (2010), Vogel et al. (2012)) Fehr (2000) Macroeconomic eects of retirement age increase may depend on the existing relation between contributions and benets Remaining gaps in the literature how the macroeconomic eects dier between various pension systems? what happens to the welfare of each aected generation and why? 4 / 32 5. Motivation and insights from literature Goals and expectations Question Can social security reform substitute for increasing the retirement age? Goal Compare macroeconomic and welfare implications of retirement age increase under DB (dened benet), NDC (notionally dened contribution), and FDC (partially funded dened contribution) systems Expectations under DB: leisure , taxes , welfare? under NDC: leisure , pensions , welfare? under FDC: leisure , pensions , welfare? Why a full model? labor supply adjustments &amp; general equilibrium eects... 5 / 32 6. Model setup 1 Motivation and insights from literature 2 Model setup 3 Baseline and reform scenarios 4 Calibration 5 Results 6 / 32 7. Model setup Model structure - consumer I born at age j = 1 (20) and lives up to J = 80 (100) endogenous labor choice up to retirement age J (forced to retire) accidental bequests are spread equally to all cohorts 7 / 32 8. Model setup Model structure - consumer II Optimizes lifetime utility derived from leisure and consumption: U0 = J j=1 j1 j,t1+j uj (cj,t1+j , lj,t1+j ) (1) where u(c, l) = log(c) + (1 ) log(1 l), (2) subject to the budget constraint (1 + c,t )cj,t + sj,t + t = (1 l,t )(1 j,t )wj,t lj,t labor income (3) + (1 + rt (1 k,t ))sj,t1 capital income + (1 l,t )pj,t + bj,t pensions and bequests 8 / 32 9. Model setup Model structure - producer Standard rm optimization implies: wt = (1 ) K t (zt Lt ) rk t = K1 t (zt Lt )1 d 9 / 32 10. Model setup Model structure - government collects social security contributions and pays out pensions of DB and NDC system collects taxes (income, capital, consumption and lump sum) spends xed share of GDP on exogenous (unproductive) government expenditure and wants to maintain long run debt/GDP ratio xed 10 / 32 11. Model setup Pension systems Dened Benet constructed by imposing a mandatory exogenous contribution rate and an exogenous replacement rate pDB j,t = t wj1,t1, for j = Jt DB t pDB j1,t1, for j &gt; Jt (4) Dened Contribution constructed by imposing a mandatory exogenous contribution rate and individual accounts Notional pNDC j,t = Jt 1 i=1 i s=1(1+rI ti+s1) NDC Jt i,ti w Jt i,ti l Jt i,ti J s= Jt s,t , for j = Jt DB t pNDC j1,t1, for j &gt; Jt (5) Funded pFDC j,t = Jt 1 i=1 i s=1(1+rti+s1) FDC Jt i,ti w Jt i,ti l Jt i,ti J s= Jt s,t , for j = Jt (1 + rt )pFDC j1,t1, for j &gt; Jt (6) 11 / 32 12. Model setup Policy scenarios What happens within each experiment? 1 Run the no policy change scenario baseline 2 Run the policy change scenario reform 3 For each cohort compare utility, compensate the losers from the winners 4 If net eect positive reform ecient Welfare analysis - LSRA like Nishiyama &amp; Smetters (2007) 12 / 32 13. Baseline and reform scenarios 1 Motivation and insights from literature 2 Model setup 3 Baseline and reform scenarios 4 Calibration 5 Results 13 / 32 14. Baseline and reform scenarios Reform of the systems Three experiments: 1 DB with at retirement age DB with increasing retirement age 2 NDC with at retirement age NDC with increasing retirement age 3 FDC with at retirement age FDC with increasing retirement age What is at and what is increasing retirement age? baseline reform at 14 / 32 15. Calibration Age-productivity prole - at or ...? heterogeneity between cohorts due to age-specic productivity, wj,t = j wt Deaton (1997) decomposition 15 / 32 16. Calibration 1 Motivation and insights from literature 2 Model setup 3 Baseline and reform scenarios 4 Calibration 5 Results 16 / 32 17. Calibration Calibration to replicate 1999 economy of Poland Preference for leisure () chosen to match participation rate of 56.8% Impatience () chosen to match interest rate of 7.4% Replacement rate () chosen to match benets/GDP ratio of 5% Contributions rate () chosen to match SIF decit/GDP ratio of 0.8% Labor income tax (l ) set to 11% to match PIT/GDP ratio Consumption tax (l ) set to match VAT/GDP ratio Capital tax set de iure = de facto 17 / 32 18. Calibration Final parameters Table: Calibrated parameters Age-productivity prole - D97 = 1 capital share 0.31 0.31 l labor tax 0.11 0.11 preference for leisure 0.578 0.526 discounting rate 0.998 0.979 d depreciation rate 0.045 0.045 total soc. security contr. 0.060 0.060 replacement rate 0.138 0.227 resulting kt investment rate 21 21 r interest rate 7.4 7.4 18 / 32 19. Calibration Exogenous processes in the model I Demographics Demographic projection until 2060, after that 80 years, and after that new steady state No of births (j=20) - from the projection, constant afterwards Mortality rates - from the projection, constant afterwards 19 / 32 20. Calibration Exogenous processes in the model II Productivity growth Labor augmenting productivity parameter Data historically, projection from AWG, after that new steady state, 1.7% 20 / 32 21. Results 1 Motivation and insights from literature 2 Model setup 3 Baseline and reform scenarios 4 Calibration 5 Results 21 / 32 22. Results Is the reform ecient? Yes! Net consumption equivalent Deaton Flat DB 9.88% 3.70% Transition to NDC 11.31% 4.41% Transition to FDC 11.81% 4.70% 22 / 32 23. Results Who gains? Everybody! 23 / 32 24. Results Why they gain? Pensions under DC systems ... 24 / 32 25. Results ... subsidies to pension system and taxes. 25 / 32 26. Results Is there any behavioral response? Of course! 26 / 32 27. Results Labor supply in the nal steady state Labor supply Labor supply with MERA increase (no reform) j &lt; 60 j 60 Total Average Average Aggregate Average Aggregate (baseline=100%) (baseline=100%) DB 63.2% 59.6% 94.4% 71.8% 113.7% NDC 62.0% 58.8% 94.8% 72.3% 114.7% FDC 61.7% 59.0% 95.5% 72.2% 115.4% 27 / 32 28. Results Aggregated labor supply (in mio of individuals) 28 / 32 29. Results Capital (per eective unit of labor) decreases 29 / 32 30. Results But mostly due to decrease in precautionary savings 30 / 32 31. Results Conclusions extending the retirement age is universally welfare enhancing some downward adjustment in individual labor supply, but the aggregated supply increases surprisingly large eect on capital 31 / 32 32. Results Questions or suggestions? Thank you! 32 / 32 </p>