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Trade-Offs in Means Tested Pension Design

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  • Chung Tran

    ()

  • Alan Woodland

    ()

Abstract

Inclusion of means testing into age pension programs allows governments to better direct benefits to those most in need and to control funding costs by providing flexibility to control the participation rate (extensive margin) and the benefit level (intensive margin). The former is aimed at mitigating adverse effects on incentives and to strengthen the insurance function of an age pension system. In this paper, we investigate how means tests alter the trade-off between these insurance and incentive effects and the consequent welfare outcomes. Our contribution is twofold. First, we show that the means test effect via the intensive margin potentially improves the insurance aspect but introduces two opposing impacts on incentives, the final welfare outcome depending upon the interaction between the two margins. Second, conditioning on the compulsory existence of pension systems, we find that the introduction of a means test results in nonlinear welfare effects that depend on the level of maximum pension benefits. More specifically, when the maximum pension benefit is relatively low, an increase in the taper rate always leads to a welfare gain, since the insurance and the positive incentive effects are always dominant. However, when maximum pension benefits are relatively more generous the negative incentive effect becomes dominant and welfare declines.

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Bibliographic Info

Paper provided by Australian National University, College of Business and Economics, School of Economics in its series ANU Working Papers in Economics and Econometrics with number 2011-550.

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Length: 37 Pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:acb:cbeeco:2011-550

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  1. Diamond, P. A. & Mirrlees, J. A., 1978. "A model of social insurance with variable retirement," Journal of Public Economics, Elsevier, vol. 10(3), pages 295-336, December.
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  6. Mikhail Golosov & Aleh Tsyvinski, 2006. "Designing Optimal Disability Insurance: A Case for Asset Testing," Journal of Political Economy, University of Chicago Press, vol. 114(2), pages 257-279, April.
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  9. Shinichi Nishiyama & Kent Smetters, 2007. "Does Social Security Privatization Produce Efficiency Gains?," The Quarterly Journal of Economics, MIT Press, vol. 122(4), pages 1677-1719, November.
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  13. Cagri Seda Kumru & John Piggott, 2010. "Should Public Retirement Pensions Be Means-tested?," DEGIT Conference Papers c015_049, DEGIT, Dynamics, Economic Growth, and International Trade.
  14. Määttänen, Niku & Poutvaara, Panu, 2007. "Should Old-Age Benefits Be Earnings-Tested?," IZA Discussion Papers 2616, Institute for the Study of Labor (IZA).
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  18. repec:nsr:niesrd:283 is not listed on IDEAS
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Cited by:
  1. Sang-Wook (Stanley) Cho & Renuka Sane, 2011. "Means-Tested Age Pension and Homeownership: Is There a Link?," Discussion Papers 2011-02, School of Economics, The University of New South Wales.
  2. Sagiri Kitao, . "Sustainable Social Security: Four Options," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
  3. George Kudrna & Alan Woodland, 2012. "Progressive Tax Changes to Private Pensions in a Life-Cycle Framework," Working Papers 201209, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.

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