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Welfare Impact of Social Security Reform: The Case of Chile in 1981

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  • Kathleen McKiernan

Abstract

In May 1981, Chile became the first country to address the unsustainability of its pay-as-you-go Social Security program by reforming to a system of individual retirement accounts. In order to quantify the welfare impact of the Chilean reform, I use an overlapping generations model with three main components: multiple productivity types, a government policy modeled on the Chilean system, and a household decision to split working time between a taxed formal sector, an untaxed informal sector, and home production. Blue-collar workers, who pay lower payroll taxes but receive lower pensions prior to the reform, and white-collar workers, who pay higher taxes and receive more generous pensions, experience long-run welfare gains of roughly 25 and 30 percent, respectively. Transitional generations of both types experience welfare losses up to 1 percent. Economies without informality and home production exhibit lower long-run welfare gains. Excluding the options for households to work informally and at home decreases welfare gains for two reasons: (1) both informality and home production increase labor supply elasticity and cause the pay-as-you-go payroll tax to be more distortionary; and (2) informality allows workers to take advantage of long-run wage increases from the reform without facing the distortion caused by remaining labor taxation.

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  • Kathleen McKiernan, 2018. "Welfare Impact of Social Security Reform: The Case of Chile in 1981," 2018 Meeting Papers 253, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:253
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    2. Joubert,Clement Jean Edouard, 2020. "Gender Pension Gaps in a Private Retirement Accounts System : A Dynamic Model of Household Labor Supply and Savings," Policy Research Working Paper Series 9322, The World Bank.

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