The Effects of Social Security on the Distribution of Wealth in Italy

Carlo Mazzaferro and Stefano TosoUniversity of Bologna

IARIW 29th General Conference Joensuu, Finland, August 20 – 26, 2006

Discussant: Panos Tsakloglou, Athens University of Economics and Business, Greece

Aims of the paper

• To estimate an “augmented” concept of wealth for Italy, where total wealth is the sum of net worth (financial and real activities, net of liabilities) plus social security net wealth

• To estimate the composition and the distribution of total (i.e. augmented) wealth among Italian households in 1991-2002

• To evaluate the distributive impact of social security wealth and the effects of pension reforms of the 1990s on wealth inequality

Literature review

• Feldstein (1974, 1976) introduced the notion of social security wealth

• Since his contribution, most studies focused their attention on the estimation of the degree of substitutability between social security wealth (SSW) and private wealth

• Much less attention is devoted to distributive implication of the introduction and growth of public pension system on wealth distribution

• Some recent exceptions: Mc Garry (1999), Kennickell and Sunden (1999), Wolff (1987, 2003, 2005),Banks et al. (2005)

Distributive impact of SSW on total wealth:main results of the literature

• SSW has a clear equalizing effect on the distribution of total wealth

• The distribution of SSW is more similar to the distribution of earnings than to that one of net worth

• Due to SSW, Gini index of total wealth in the US decreases by around 15 to 20 percent (Wolff 2005)

• Net worth is much more concentrated than SSW in the top 5 percent of the population

• Over time the mitigating effect of SSW on total wealth inequality in the US has been decreasing

• Existing studies on wealth distribution for Italy do not include an estimate of SSW and its distributive impact

Jappelli and Pistaferri 2000: the distribution of net worth is more right-skewed and dispersed than the distributions of consumption and disposable income; strong positive correlation between income and wealth.

Brandolini et al. 2004: dwellings are the main components of household wealth; asset holding vary considerably across household deciles; steady increase in wealth inequality during the 1990s, driven by large gains of financial assets at the very top of the distribution.

Faiella and Neri 2004: tangible assets are the main wealth component both in Italy and US; the US households hold a higher share of financial assets and show a greater propensity to invest in more risky portfolios.

Data sources and accounting framework

• Data source: historical archive of the Survey of Household Income and Wealth (1991-2002) by the Bank of Italy

• The basic unit of observation: household

• No equivalence scale is used

• Data adjusted to correct for the probabilities of avoiding the interview (non-response), and for non-reporting and under-reporting (especially with respect to financial assets and dwellings not occupied by their owners)

Definition of total (“augmented”) wealth

TW = AR + AF – PF + SSW

AR: real assetsAF: financial assetsPF: financial liabilitiesSSW: present value of future streams of pension

benefits net of expected contributions still to pay from the time of observation until retirement

• AR, AF, PF: directly taken from SHIW data• SSW: estimated from data of earnings and pensions

in SHIW data

Computation of social security wealth

1. All values in 2002 Euro. Perfect knowledge of pension rules

2. Retirement through a dual path: seniority pension or legal retirement age

3. Life expectancies taken from the National Statistical Office (Istat)

4. Lifetime earnings estimated from SHIW data5. Constant real wages growth and real discount rate6. Indexation of pensions: 1991 to real wages and

prices; afterwards to prices only

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Estimation of earning profiles

• Grossing up of net income, using the personal income tax structure of each year

• Nine stylized earning profiles obtained by regressing the log of gross earnings on a polynomial on age for different subgroups of the population by education (primary, secondary, tertiary), occupation (employees and self employed) and gender

• Estimated gross wages: regression coefficients using a constant real annual growth (1,5%)

Gross earning profiles by gender and level of education. Employee males and females

9

9.2

9.4

9.6

9.8

10

10.2

10.4

10.6

10.8

20 25 30 35 40 45 50 55 60 65

Primary Secondary Tertiary

9.1

9.2

9.3

9.4

9.5

9.6

9.7

9.8

9.9

10

10.1

20 25 30 35 40 45 50 55 60 65

Primary Secondary Tertiary

Gross earning profiles by level of education.The self-employed

9.4

9.6

9.8

10

10.2

10.4

10.6

10.8

25 30 35 40 45 50 55 60 65

Primary Secondary Tertiary

• It takes into account the effects of the three restrictive pension reforms of the nineties (1992, 1995 and 1997)

• Pensioneers: net value of pension benefits is taken from SHIW and grossed up

• Active population: four different groups according to seniority in 1995 in order to take into account the different speed of reforms by generations:

1. All individuals from the 1991 survey (no reform had been enacted yet in 1991)

2. Workers with at least 18 years of contributions in 19953. Workers with less than 18 years of contributions in 19954. Workers who entered the labour market after 1995

Computation of pension benefits

• Self-employed and employees considered separately

• Two exit routes:1. Seniority pensions: immediately if possible

2. Legal retirement age: otherwise

Conclusions 1/2• Total wealth in Italy remained roughly constant during

the last decade as the result of an increase in net worth and a stronger, parallel decline in SSW, due to the two main pension reforms (1992, 1995)

• Key factors underlying the reduction in SSW: abolition of indexation of pensions to real wages growth after 1991, and changes made to the computation of pension benefits

• Wealth inequality, after steeply rising at the beginning of the 1990s, levelled off in the second part of the period. The major contribution to the initial rise came from SSW

• The pension reforms of the 1990s seem to have reduced the equalising effect of social security wealth on augmented wealth

Conclusions 2/2

• SSW inequality shows an increasing trend for all age classes, and is particularly marked among young households

• In 1991 total wealth inequality basically depended on both real assets and SSW. A decade later, real assets maintained a primary role, while the relative contribution of SSW became smaller. Financial assets acquired a considerable weight in explaining total variability

• The results of the decomposition of inequality into different population subgroups sorted by some socio-demographic categories show that overall inequality in total wealth is mainly accounted for the within-component, while the between-component seems to play a marginal role

Comments and suggestions

• Very meticulous work; definitely a contribution to the literature.• However

What do we really measure?Are there any policy implications?(perverse incentives for low wage earners?)

Suggestions:• Introduce unemployment and employment interruptions in

earnings profiles• Treatment of the unemployed• Life expectancy (sex or sex and education?)• Unit of analysis: Individual rather than household• Use statistical inference to test significance of changes• Provide elasticities in Gini decomposition• Use Theil indices in decompositions by population subgroup