Academic journal article National Institute Economic Review

Household Saving Rates and the Design of Public Pension Programmes: Cross-Country Evidence

Academic journal article National Institute Economic Review

Household Saving Rates and the Design of Public Pension Programmes: Cross-Country Evidence

Article excerpt

I argue that the offsetting effect of public pension contributions on household retirement saving depends on how closely the public pension programme imitates a private retirement saving plan (i.e. the 'actuarial' content of the public pension programme)--the closer the design of the programme to a private retirement saving plan, the higher the offset. I estimate the determinants of household saving rates in a cross-country panel, augmenting standard measures of public pension programme generosity and cost by indicators that proxy the actuarial component of the programme. These indicators affect saving rates as predicted.

Key words: Pension reform; Household saving JEL classifications: E21; G23; H24

I. Introduction

Standard life cycle theory and a large empirical literature argue that public pension programmes, which provide benefits after a certain age financed out of general or hypothecated taxes, affect household behaviour. First, public provision of retirement income affects the propensity of households to engage in private retirement saving and also their wealth decumulation strategy later in life. Second, by driving a wedge between the pre- and post-tax wage, publicly-provided pensions affect the gains from work and therefore the optimal length and intensity of the working life. Although studies differ in what they are testing and how they test it, there seems to be general agreement that public pension programmes affect household behaviour in direct proportion to the average level of pension contributions (being a large component of the tax 'wedge'), in proportion to the generosity of the public pension programme (the average 'replacement rate') and in relation to any specific disincentives to work and save late in life (e.g. retirement tests, means-testing of retirement incomes, and the like).

The literature pays rather less attention to how the design of public pension programmes affects these dimensions of household economic activity. Public pension programmes vary substantially in their provisions--not just in average generosity but also in, for example, how closely individual public pension entitlements are related to individual contributions, in generational differences in the implicit 'rate of return' on contributions relative to rates of return available in the capital market, and so on. The implications of programme heterogeneity for household behaviour have not always been thought through in the existing literature, and variations across countries and over time have certainly not been exploited (to my knowledge) to test the underlying theory. This is the purpose of the present paper.

To illustrate programme heterogeneity: some recent public pension reforms (notably in Germany, Italy and Sweden) have been designed explicitly to make the public pension programme 'fairer' in some actuarial sense (i.e. so that individual benefits are more closely matched to individual contributions). There is an implicit assumption that this will 'improve incentives' and thereby affect household behaviour. In effect, making a tax-financed programme appear to be like a private retirement saving plan may cause individuals to interpret public pension contributions less as a tax and more as a mandatory saving contribution so that the 'tax wedge' impact on employment is reduced. However this occurs at the expense of making public pensions a closer substitute for private retirement saving and thereby potentially reducing private retirement saving. In contrast, greater targeting of public pension benefits on poorer pensioners (as has happened in, for example, the United Kingdom since the mid-1990s) will certainly increase the disincentives both to save and to work later in life for prospective recipient households but, by making the programme look less like an actuarial programme, will have quite different effects on other, better-off, groups in the population. The net effect on incentives to save and work later in life may go in either direction depending on the exact design features of the programme, preferences, rates of return and so on. …

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