Academic journal article Contemporary Economic Policy

Some Notes on the Redistribution Inherent in the U.S. Public Pension System

Academic journal article Contemporary Economic Policy

Some Notes on the Redistribution Inherent in the U.S. Public Pension System

Article excerpt

I. INTRODUCTION

It is generally taken for granted that the rules of the Old-Age and Survivors Insurance (OASI) offered by the U.S. social security system--unlike many defined-benefit (DB) schemes, especially those based on the last earnings rule--achieve a progressive redistribution, given that lower accrual rates are applied to higher income brackets. In fact, debate on the OASI redistributions has generally focused on the interaction of its basic progressive design with other, possibly regressive and more or less transparent, sources of redistribution embedded within the system. Liebman (2002) has shown that most of the redistribution generated by OASI comes from factors other than lifetime income and that the marked dispersion of the individual internal rates of return (IRRs) for a given lifetime income can be attributed to differences in life expectancies, family status, and career length. Similar results have been reached, by Caldwell etal. (1999), Gustman and Steinmeier (2001), and Coronado et al. (2002). The underlying idea of this strand of the literature is that, once the correlation between income and life expectancy is taken into account, the intra-cohort redistribution generated by the U.S. pension rules is much less progressive than its defenders seem to believe.

The aim of this paper is to draw some policy implications by exploring the extent to which the seemingly progressive pension formula of the U.S. program is actually able to avoid the regressive redistributions that, typically, arise within DB schemes according to differences in career patterns. (1) In order to do so, we limit our analysis to the Old-Age Insurance (OAI) of the entire U.S. social security system, thus disregarding the redistributions generated by its Survivor (SI) and Disability (DI) programs. The distributions in favor of single-earner couples, associated with spouse benefits, will also be disregarded.

The benchmark against which we measure possible deviations of the OAI scheme from its aim to redistribute from high- to low-income earners is the award formula and adjustment rule of the new variety of old-age pension system, started in the early 1990s in Italy and in Sweden, that "implants" the non-redistributive formula of defined-contribution (DC) systems into pay-as-you-go (PAYG) financing. Since then, other countries have followed suit and important institutions, like the World Bank, are sponsoring the adoption of what is now known as the "Notional" or "Non-financial" Defined Contribution (NDC) scheme (see Holzmann and Palmer 2006; Holzmann, Palmer, and Robalino 2012). (2) If properly managed, the NDC scheme can ensure a substantial degree of financial stability under varying economic and demographic conditions, for any given contribution rate. A second, crucial, property of the scheme is its transparency. It is, in particular, the actual crediting of a uniform rate of return on all individual notional accounts that allows the NDC scheme to eliminate all hidden, and mostly regressive, redistributions typical of the DB, earnings-related schemes. We will, for our purpose, use the term "fairness" to refer to this property of the NDC scheme to reward individual compulsory savings evenly, though we are perfectly aware that it should not be burdened with any reference to equity. Moreover, especially when, as is the case in Sweden, individuals are informed year by year of the development of their notional accounts and the rate of return earned on their pension wealth, the new scheme allows social security contributions to be perceived as compulsory savings rather than as taxes, as it is in funded DC systems. (3)

This is why the NDC scheme should be considered a further policy option in the debate about U.S. public pensions that has, so far, focused on whether the ongoing worsening of the demographic scenario should be addressed by shifting from PAYG financing to a funded, private retirement system (e. …

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