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The strengths and failures of incentive mechanisms in notional defined contribution pension systems

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  • A. Marano
  • C. Mazzaferro
  • M. Morciano

Abstract

Public pension systems based on the Notional Defined Contribution (NDC) principle were introduced during the ‘90s in Italy, Sweden and Poland, among other countries. They mimic private savings, in that individuals get back, as pensioners, what they contributed to social security during working life, plus returns. As such, NDC systems should realize actuarial equity and incentive neutrality. However, when one considers the presence of NDC pensions together with minimum and social assistance pensions, this is no longer true. Indeed, in all the three countries considered, the NDC system shows a regressive feature, which disincentivizes contributions, particularly from low earners, who would be better off entering, or staying in, the shadow economy. In order to reduce the extent of this phenomenon, we examine the effects of introducing, or increasing, the possibility of accumulation of social assistance and NDC pensions, which would also improve pension adequacy. A complete accumulation of the two would solve the incentive problem, but would be costly and would require a structural reform of the pension system financing mechanism, altering the current balance between social contributions and general fiscal revenues. We show the effects of a change in the cumulation rules for social assistance and NDC pensions in Italy using CAPP_DYN, a population-based dynamic microsimulation model, which allows assessment of the evolution of the pension system in the coming decades and the distributional implications of such reform.

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Paper provided by Dipartimento Scienze Economiche, Universita' di Bologna in its series Working Papers with number wp799.

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Date of creation: Nov 2011
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Handle: RePEc:bol:bodewp:wp799

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  1. Giovanni Guazzarotti & Pietro Tommasino, 2008. "The Annuity Market in an Evolving Pension System: Lessons from Italy," CeRP Working Papers 77, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  2. Carlo Mazzaferro & Marcello Morciano, 2012. "CAPP_DYN: A Dynamic Microsimulation Model for the Italian Social Security System," Center for the Analysis of Public Policies (CAPP) 0048, Universita di Modena e Reggio Emilia, Dipartimento di Economia Politica.
  3. Edmund Cannon & Ian Tonks, 2003. "UK annuity rates and pension replacement ratios 1957-2002," LSE Research Online Documents on Economics 24832, London School of Economics and Political Science, LSE Library.
  4. Chlon-Dominczak, Agnieszka & Strzelecki, Paweł, 2010. "The minimum pension as an instrument of poverty protection in the defined contribution pension system – an example of Poland," MPRA Paper 25262, University Library of Munich, Germany.
  5. Giuseppe Carone & Herwig Immervoll & Dominique Paturot & Aino Salomäki, 2004. "Indicators of Unemployment and Low-Wage Traps: Marginal Effective Tax Rates on Employment Incomes," OECD Social, Employment and Migration Working Papers 18, OECD Publishing.
  6. Carlo Mazzaferro & Marcello Morciano, 2011. "Measuring intra-generational and inter-generational redistribution in the reformed Italian social security system," Working Papers 11, Department of the Treasury, Ministry of the Economy and of Finance.
  7. Mazzaferro, Carlo & Morciano, Marcello & Savegnago, Marco, 2012. "Differential mortality and redistribution in the Italian notional defined contribution system," Journal of Pension Economics and Finance, Cambridge University Press, vol. 11(04), pages 500-530, October.
  8. Massimo Baldini & Carlo Mazzaferro & Marcello Morciano, 2007. "Assessing the implications of long term care policies in Italy: a microsimulation approach," Center for the Analysis of Public Policies (CAPP) 0035, Universita di Modena e Reggio Emilia, Dipartimento di Economia Politica.
  9. Monika Queisser & Edward R. Whitehouse, 2006. "Neutral or Fair?: Actuarial Concepts and Pension-System Design," OECD Social, Employment and Migration Working Papers 40, OECD Publishing.
  10. Edward R. Whitehouse, 2010. "Decomposing Notional Defined-Contribution Pensions: Experience of OECD Countries' Reforms," OECD Social, Employment and Migration Working Papers 109, OECD Publishing.
  11. Allison Schrager & G. A. Mackenzie, 2004. "Can the Private Annuity Market Provide Secure Retirement Income?," IMF Working Papers 04/230, International Monetary Fund.
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