Noncontributory subsidies for the old poor (first-pillar pensions) affect the welfare of hundreds of millions around the world. Their benevolent rationale is to redistribute progressively, subject to efficiency considerations. This paper focuses on a critical efficiency issue: first pillars may affect another, even bigger program, namely contributory pensions for the middle classes, by inducing a reduction in the density of contributions. A major source of concern with contributory pensions in emerging economies is that the total replacement rate is too small for participants with low density, which are prevalent. The paper develops a model where density of contribution is endogenous, because for a substantial subset of jobs, the State is unable or unwilling to impose a mandate to contribute. Thus, the job selection decision is bundled with a saving decision. The first finding is that bundling modifies the effective rate of return on contributions, raising it without bound as earnings in uncovered jobs become smaller (relative to earnings in covered jobs). Another finding is that the standard designs of first-pillar pensions reduce the equilibrium density of contributions. Thus, standard first-pillar designs do crowd out contributory pensions for the middle classes. The paper then analyzes two second-generation designs. The “proportional” minimum pension is found to create horizontal inequity and inefficiency. In contrast, a subsidy with a small withdrawal rate applied to contributory pensions minimizes the loss of contribution density. Optimal income taxation theory suggests that the latter also provides the most efficient progressive redistribution.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Instituto de Economía. Pontificia Universidad Católica de Chile. in its series Documentos de Trabajo with number
335.
Find related papers by JEL classification: H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions H53 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Welfare Programs H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
This paper has been announced in the following NEP Reports: